Cliffs Natural Resources (CLF), the biggest U.S. iron ore producer, reported 3Q13 operating EPS of $0.81, beating consensus estimates of $0.73 by 8 cents. Results for the company's U.S. Iron Ore and Coal segments came in better than expected and largely drove the beat.
Strong cost controls helped the company post impressive quarterly results. A big decline in cost in the coal segment is noteworthy, particularly if the company can sustain it. However, the mid-point of new full-year 2013 guidance implies less upside to previous guidance than the size of the 3Q13 beat. More importantly, there was no update in the earnings release on key investor concerns such as the future of Bloom Lake Phase II and Wabush and U.S. iron ore contract pricing trends.
Bloom Lake Remains A Challenge
Bloom Lake Mine, which CLF acquired with its 2011 purchase of Consolidated Thompson Iron Ore Mines, continues to be the biggest concern of investors. Mitigating the improving 2014 volume picture in U.S. Iron Ore is the lack of projected improvement at Bloom Lake. Full year cash cost per ton for Bloom Lake and Wabush mines are expected to track previous levels of $90-$95 and $115-$120, respectively. Until the company resolves its ore-blend and grinding issues and lifts output closer to the revised capacity of 7.0 million tons vs. guidance of 5.5-6.0 million tons, it makes little sense to restart the phase 2 expansion, which is effectively a replica of phase 1. The updated guidance of only 5.5-6.0 million ton appears to be another shortfall on what was once an 8 million ton per annum asset and until recently 7 million ton per annum.
New Leadership A Positive
Following the quarterly results CLF announced that it has hired Gary Halverson, a former interim chief operating officer of Barrick Gold Corporation (ABX), to be its new CEO. Halverson will start November 18 as the President and COO before eventually assuming the CEO role. At ABX, Halverson had headed the company's North American operations after overseeing the Australia division. A seasoned executive with operational expertise is positive for CLF, because he can bring exactly the type of leadership that Cliffs needs at this time to optimize its portfolio and drive the turnaround of Bloom Lake. CLF's current CEO, Joseph Carrabba, announced his retirement in July and will leave on November 15.
CLF has a forward P/E of 13.7, compared to 15.2 of S&P 500. The company has a price-to-book ratio of 0.8 compared to the industry average of 2.1 and CLF's own 5 years average of 2.0. It has a price-to-sales ratio of 0.7 compared to the historical average of 1.5 and industry average of 1.8. Finally, CLF has a price-to-cash flow ratio of 4.2 compared to the industry average of 9.0.
CLF's new management lineup, noteworthy cost reductions and more realistic approach toward capital allocation are steps in the right direction. The company is finally willing to acknowledge many of the issues that investors and analysts have been highlighting for the past year, and is working towards finding solutions.
The company's Canadian operations remain a concern, where cash costs rose 21% to $106.06 per ton. Costs at Bloom Lake rose 18% Y/Y, driven by higher fuel, labor, maintenance and supply costs. However, troubles at Bloom Lake aside, CLF is doing an impressive job improving costs at the rest of its operations. U.S. iron ore costs are tracking at the low end of guidance and could improve more in 2014.
Although the company posted an impressive quarter and is taking steps in the right direction, it is still not out of the woods. CLF's entire business model is built around a bullish iron ore price call. Although iron ore prices continue to show surprising strength we remain cautious on the outlook of iron ore prices as the seaborne market transits from a balance state to surplus. If you are not an iron ore price bull then the whole investment thesis is frankly pretty unconvincing. For CLF to come out and imply a more cautious view on long-term iron ore almost undermines the integrity of its entire business model. Eastern Canada Iron Ore operations in particular continue to disappoint. The 2014 sales expectations of 5.5-6.0 million tons at Bloom Lake also imply that current crushing/milling issues remain unresolved. We believe if you want to take a position in iron ore, BHP Billiton and Rio Tinto offer much better value than CLF. You can read our articles on BHP and RIO on the following links.