Lower Iron Ore Prices Will Impact Cliffs Natural's Results

Apr.23.13 | About: Cliffs Natural (CLF)

Cliffs Natural Resources (NYSE:CLF) will announce its first quarter results on April 24, 2013. Given the lower iron ore prices this year, we expect the company to post lower year-over-year revenues and profits.

The company is facing challenging times right now in both its business segments: iron ore and coal. Commodity prices have been tumbling, especially for copper, iron ore and aluminum. A lot of the blame could be ascribed to slowing Chinese growth, but there are other issues such as surplus capacity, which are accentuating the negative trend. (LME Copper Prices)

In March, Cliffs announced the idling of its Wabush Pointe Noire iron ore pellet plant in Canada due to high production costs and lower pellet premium pricing. The idling will take place by the end of the second quarter this year.

Last heard, the company has still not been able to reach a final agreement with the First Nations communities. First Nations are autonomous aboriginal communities who live in close proximity to Cliffs’ chromite properties, and are concerned about jobs, business opportunities and improved infrastructure. Due to the diverse nature of these communities and wide-ranging concerns, progress has been slow and negotiations complicated. Failure to reach an understanding on time may delay its chromite projects further.

Falling Iron Ore Prices A Major Concern

As expected, this year began on a positive note for iron ore miners. The price of iron ore continued to rise in January and February from the previous quarter due to restocking by Chinese steel mills. However, once the restocking was done by the end of February, prices started falling. The Chinese government then came out with stringent rules to curb the housing market, which appeared to be in a bubble. This reduced the demand for steel, in turn impacting the demand for iron ore.

China is the world’s biggest consumer of commodities and its economic growth data for the first quarter was below expectations. It reported a Gross Domestic Product (GDP) growth rate of 7.7% in Q1 2013, which was much lower than market estimates and the previous quarter’s figure of 7.9%. This belied the belief that the Chinese growth rate had bottomed out last quarter and would only go up in the future. As a result, the prices of nearly all major commodities, including iron ore, took a beating.

Going forward, the growing role of scrap in Chinese steel production and increasing investment in Chinese domestic iron ore production will keep demand growth in check.

Iron ore miners are in for a double whammy as supplies are expected to surge over the next few years. According to the Bureau of Resource and Energy Economics (BREE), the official Australian commodities forecasting agency, iron ore prices will decline going forward and reach its lowest levels around 2018. This is due to a lot of additional production capacity scheduled to come online in this period and a non-commensurate expected rise in demand. Beyond 2018, the balance between demand and supply is likely to be more even. (Australia predicts fall in iron ore price, Financial Times)

Cliffs faces more challenging times than its bigger rivals like Vale (NYSE:VALE), Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) who have much lower cash costs per ton of iron ore and coal.

Other Business Developments

Cliffs will idle its Wabush Pointe Noire iron ore pellet plant in Canada by the end of the second quarter as the current cost structure there is not sustainable. The Wabush facility also has a concentrator and the company will transition to producing only iron ore concentrate from here in the future. However, Cliffs has maintained its 2013 sales and production volume expectations of 9–10 million tons from the Eastern Canada business segment to which Wabush belongs. As a result of idling the pellet plant, 2013 cash cost per ton in the Eastern Canadian Iron Ore segment is expected to be $95-100, down from the company’s previous expectation of $100-105.

The feasibility study on the Black Thor chromite project is on schedule and is expected to complete later this year. The company is keen to bring in more partners into the project to share capital costs and risks. Any meaningful discussion is expected to begin once the feasibility of the project is established. Due to the diverse nature of the First Nations communities and wide-ranging concerns, progress has been slow and negotiations complicated. Progress has also been tardy towards signing of a definitive agreement between the company and the Ontario government, without which production cannot begin in 2016. (Ring of Fire project has staggering hurdles to overcome, but progress on horizon, Financial Post)

Our price estimate for Cliffs Natural Resources is $36, which will be revised once the first quarter earnings results are out.

Disclosure: No positions.