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Cliffs Natural Resources (NYSE:CLF) is set to announce its second quarter earnings on Wednesday. We are expecting the company post a decline in net income on a year-over-year basis. Iron ore prices have significantly declined from levels seen a year ago even as shipments could increase for the company. Also, the slump in U.S. thermal coal demand will likely hit the company's revenues. We expect that falling prices of heavyweight iron ore will drag the company's overall margins down. Rising energy, labor and other input costs will also put pressure on margins. Cliffs is the largest producer of iron ore pellets in North America and a major supplier of direct-shipping lump and fines iron ore out of Australia. It is also a significant producer of metallurgical coal.

Our price estimate for Cliffs Natural Resources is at $71, which is about 60% ahead of the current price of the company's stock.

See Full Analysis for Cliffs Natural Resources Here

Iron Ore Prices Slump, Coal Demand Declines

As a result of economic conditions in the eurozone and a slowdown in demand from China, iron ore prices crashed to about $135 in the second quarter, significantly down from the $180 levels seen last year. However, iron ore shipments may continue to grow following its acquisition of Thompson Consolidated last year.

As evidenced by the railroad companies' Q2 results, U.S. thermal coal demand has suffered a severe blow as natural gas substitutes coal demand. Further, the EPA's recent regulations effectively barring new coal-fired power plants has also played a major role in the demand slump. The company recently revised its 2012 thermal coal sales and production volume outlook down from 1.1 million tons to about 800,000 tons. But, metallurgical coal, which contributes significantly more than thermal coal, is expected to continue to grow due to its long term relationship with major steel manufacturers.

Long Term Outlook Solid, Asia Pacific to Drive Growth

On a long term basis we remain optimistic about the company's prospects. Healthy automotive should drive steel demand in the North America, which should translate into an increase in iron ore demand.

The company is eying the Asia-Pacific region to tap into the continued strong demand compared with the stagnant outlook in North America. Cliffs is expecting demand from emerging markets, primarily China, to be a major source for its growth. In 2012 the company expects to sell nearly half of its 45+ million tons of expected global iron ore sales to seaborne customers in the Asia Pacific region, with the remainder being sold to North American customers. However, sustained weak iron ore prices could dampen the mood.

Our primary concern stems from the fact that the North American iron ore and coal divisions' revenues are highly dependent on a few customers – ArcelorMittal (NYSE:MT), Algoma and Severstal together make up about 35% of Cliffs' total revenues. A loss of sales to any of these existing customers could have a substantial adverse impact on the company's revenues and profitability.

Disclosure: No positions

Source: Cliffs' Q2 Earnings Will Show Iron Ore Weakness