Cliffs Natural Resources: Deconstructing The Q1 Earnings Report

Apr.29.14 | About: Cliffs Natural (CLF)

Summary

Cliffs first quarter earnings delivered results that were far below analyst estimates on both earnings and revenues.

Revenues from both coal and iron ore were down significantly in the United States, Canada and the Asia Pacific regions.

Cliffs reiterated 2014 guidance, but actual results will largely be determined by the state of iron ore prices.

Cliffs continues with its capital expenditure reduction program that it has been executing for the last few quarters.

Planned infrastructure spending in China and Canada along with the company's supply deal with ArcelorMittal could improve future results.

Recently, I published a piece detailing what was going well and not so well at Cliffs Natural Resources (NYSE:CLF). I talked about how one of the worst things going for Cliffs right now is how the company is being adversely impacted by falling iron ore prices. That was proven in spades, as Cliffs delivered its first quarter earnings report, and the results were brutal.

Cliffs reported a loss of 54 cents per share in the first quarter, which was far below analyst expectations of a loss of 23 cents. Similarly, revenues came in at $940 million, which was also below estimates of $957 million and well below the prior year quarter's $1,140 million figure. To blame, according to the company, are falling iron ore prices, falling met coal prices and bad weather across several regions. On the positive side, the company reaffirmed its 2014 guidance, but noted that those numbers would be dependent on iron ore prices.

None of this news is terribly surprising, as investors have known for a while that the drop in ore prices was going to hit the company's bottom line. The cold weather across the Midwest was a bad break, but it also demonstrates that operations in the northern United States and eastern Canada will be dependent on factors like the weather that Cliffs is unable to control. It's probably less than likely that the Great Lakes will be completely frozen over for a second straight winter, but it is another variable in the equation.

Irrespective of the weather issues, revenues were down across the board regardless of region or product. Iron ore revenues were down 9% year-over-year in the United States, 25% in Canada and 19% in the Asia Pacific region. The primary factor to blame here was iron ore pricing, but results were also impacted by exchange rates and weather-related sales declines. The coal market told a similar story. Revenues were down 20% again due to falling prices, while the cost per ton was up around 10% - another theme that existed pretty much across the board.

While it's encouraging that the company reiterated its 2014 forecast numbers, it's hard to know what really to expect until we know what iron ore prices will be for the next 3-6 months. Prices are not currently at the level where Cliffs can sustain profitability. Cliffs really needs the price of ore to be above $130 - right now, it's floating around the $110 mark - in order to meaningfully boost revenues and net income. If the current slide in ore prices were to continue, Cliffs management might be forced into a position of needing to make some tough choices regarding production and/or divesting itself of some low-performing assets.

The company also confirmed that it is continuing to move forward with its cost-cutting program, which should be welcome news. Capital expenditures, as expected, were down over 50% as the company attempts to limit expenses in a lower revenue environment.

Conclusion

It depends on whether you want to be optimistic or pessimistic, but I think there's a lot more here to loathe than to like. In the end, it really all comes down to the price of iron ore (and to a lesser extent, the price of coal).

Operationally, there are reasons for optimism. Weather-related slowdowns should be limited over the next few quarters, given the warmer weather, which should help. The government of China seems committed to expanding infrastructure spending, which should improve the demand for Cliffs' products in the Asia Pacific region. Recently, Ontario's government announced that it was prepared to spend up to C$1 billion in infrastructure, which could be a boon to Cliffs' chromite project, which is currently on the shelf. Its supply deal with ArcelorMittal (NYSE:MT) could also add to the bottom line.

But if prices for iron ore don't start pushing northward again, the gains seen from any of the scenarios above may be nullified by depressed revenues, and Cliffs could be in for more tough times ahead.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.