My previous article on Cliffs Natural Resources (NYSE: CLF) was titled "Cliffs Natural Resources: 3 Reasons For A Quick Rally". The rally did happen, and now the company's shares look set for further upside given Cliffs' first-quarter results.
Here are the key reasons for further upside. The company's U.S. iron ore cash production cost decreased from $64.98 in the first quarter of 2015 to $47.88 in the first quarter of 2016. First quarter is always the weakest for Cliffs due to seasonality, so it makes sense to follow the year-over-year comparisons rather than look at sequential numbers.
Similar improvements were seen in the Australian segment, where the cash production cost decreased from $36.77 in the first quarter of 2015 to $26.90 in the first quarter of 2016. The progress is remarkable. Cliffs' management clearly proved their ability to push costs down. I did not expect that much improvement in just a year.
The pricing outlook improved due to the recent changes in the iron ore and steel market. The company's Australian segment is the main beneficiary. When Cliffs' reported its fourth-quarter results, it expected to get $28 - $30 per ton of iron ore when the IODEX price was $40 per ton. Now, prices of $33 - $35 per ton are expected at $40 IODEX price.
The strength of the iron ore rally caught me by surprise, and I remain cautious regarding the iron ore's ability to stay at elevated levels throughout the year. Nevertheless, each day of higher iron ore prices benefits Cliffs' Australian segment, and this factor should be taken into account.
Despite recent strength, Cliffs did not change its outlook for the year. The only major change is the increase in capital spending budget to $75 million from $50 million in order to meet a certain customer specification. Given the recent market improvements, this increase won't have a negative impact on the company's finances.
Cliffs finished the first quarter with just $60 million of cash, which is typical for the first quarter. Long-term stand stands at $2.5 billion, so, despite all the positive actions to reduce debt, there's still plenty of work to be done. With the first quarter behind, Cliffs will build up its cash position, potentially opening doors for further debt management actions.
All in all, Cliffs' report clearly showed that the worst is behind the company. Ideally, investors would like to see an increase in production guidance that would have signaled serious demand strength, but this is probably a big wish in the current point of the cycle. In my view, Cliffs shares are set to test recent highs driven by strong cost performance and market improvements.
The main risk remains the possible downside in iron ore prices, which have been influencing the company's capitalization in recent months. While I am skeptical that iron ore prices play the main role in Cliffs' valuation for the longer term due to the company's strategy to focus on the production of pellets in the U.S., the market seems to have a different opinion which could not be ignored.
The other risk is the termination of the current commodity rally as a whole, which will lead to basket sales of all commodity-related equities.
Despite these risks, I am optimistic about the future perspectives of Cliffs' shares.
Disclosure: I am/we are long CLF.
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.