Cliffs Natural Resources Inc.
/ (CLF-NYSE)We are upgrading our recommendation on Cliffs Natural Resources to Neutral factoring in its cost management initiatives. Both adjusted earnings and sales for the second quarter topped Zacks Consensus Estimates. However, reported profit slid on hefty impairment charges and lower prices. Cliffs remains hamstrung by lower iron ore pricing, partly due to oversupply in the industry. The company also contends with higher labor and mining costs. Nevertheless, Cliffs remains optimistic regarding prospects for cash generation and the opportunities that will fund organic growth projects and return cash to shareholders. It also has a significant presence in the Asia-Pacific region, where demand is still robust, lending support to shipments. Management is also focusing on improving cost structure.
/ Equity Research / CLF | Page 1
Current Recommendation / NEUTRAL
Prior Recommendation / Underperform
Date of Last Change / 09/24/2013
Current Price (09/23/13) / $21.89
Target Price / $23.00
SUMMARY
/ Equity Research / CLF | Page 1SUMMARY DATA
52-Week High / $45.7952-Week Low / $15.68
One-Year Return (%) / -43.78
Beta / 2.47
Average Daily Volume (sh) / 6,740,291
Shares Outstanding (mil) / 178
Market Capitalization ($mil) / $3,896
Short Interest Ratio (days) / 5.27
Institutional Ownership (%) / 77
Insider Ownership (%) / 1
Annual Cash Dividend / $0.60
Dividend Yield (%) / 2.74
5-Yr. Historical Growth Rates
Sales (%) / 22.2
Earnings Per Share (%) / 8.7
Dividend (%) / 51.1
P/E using TTM EPS / 8.0
P/E using 2013 Estimate / 8.2
P/E using 2014 Estimate / 14.8
Zacks Rank*: Short Term
1–3 months outlook / 2 - Buy
* Definition / Disclosure on last page
Risk Level * / Above Avg.,
Type of Stock / Mid-Value
Industry / Mining -Iron
Zacks Industry Rank * / 35 out of 267
OVERVIEW
Cliffs Natural Resources Inc. – formerly Cleveland-Cliffs Inc. – is the largest producer of iron ore pellets in North America with a 45% share, besides being a major supplier of metallurgical coal in North America with a 30% share. The company operates six iron ore mines in Michigan, Minnesota and Eastern Canada as well as three coking coal mines in West Virginia and Alabama. Cliffs’U.S. based mines has a rated capacity of 32.9 million gross tons of iron ore pellet production annually, representing about 57% of the totalU.S. pellet production capacity. Based on the percentage of ownership in the mines operated, the company’s share of the rated pellet production capacity is currently 25.5 million gross tons annually, representing about 44% of the total U.S. annual pellet capacity.
The reportable segments of Cliffs are U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal and Asia-Pacific Iron Ore.
The U.S. Iron Ore andEastern Canadian Iron Ore segment comprises Cliffs’ ownership in 3 mines in Minnesota (Hibbing Taconite, Northshore and United Taconite mines), 2 in Michigan (Empire and Tilden mines) and 2 in eastern Canada. The company produced22 million tons of iron ore pellets at U.S. Iron Ore in 2012. At Eastern Canadian Iron Ore, it produced 8.5 million metric tons of iron ore pellets in 2012.
Cliffs own and operate 5 metallurgical coal mines situated in West Virginia and Alabama and 1 thermal coal mine located in West Virginia. The company sold 6.5 million tons in 2012 versus4.2 million tons in 2011.
The Asia-Pacific Iron Ore division includes the company’s iron ore assets in Western Australiaincluding its wholly owned Koolyanobbing complex and 50% equity interest in CockatooIsland. The segment registered total production of 11.3 million metric tons in 2012.
Cliffs, in July 2012, entered into a definitive share and asset sale agreement to sell its 45% economic interest in Sonoma Coal joint venture inAustralia to QCoal Sonoma Pty Ltd (QCoal). The transaction closed in the fourth quarter of 2012 and Cliffs collected net cash proceeds of AUD $141 million.Sonoma produced roughly 2.8 million metric tons of coal in 2012.
Cliffs is also divesting its interest in the Amapajoint venture with Anglo American in Brazil to a single entity. Cliffs holds a 30% stake in the Amapa mine while the rest is owned by Anglo American. The company recorded non-cash impairment charge of $365.4 million in 2012 related to the sale (expected to close during the first half of 2013). Amapaproduced6 million metric tons of iron ore fines in 2012.
Cliffs recently announced that its president and chief executive officer (CEO) Joseph Carrabba will be retiring from his post by December 31, 2013. Carrabba, however, will continue to serve as president and CEO and a director of the company until a successor is elected.Cliffs has named James Kirsch its non-executive chairman, effective immediately. He had been the company's lead director.
REASONS TO BUY
Cliffs’ expansion project at the Empire and Tilden mines, along with increased ownership from 70% to 100% in the United Taconite mine in Minnesota, is expected to increase iron ore pellet production capacity. Currently, about 64% of the company’s blast furnaces are running in North America. With additional restarts expected, steel-making capacity utilization will reach roughly 70% in the near future.
Cliffs is also focusing on growing its international exposure. The acquisition of Wabush mine is consistent with this approach, as production will be directed primarily toward Europe. Wabush's total annual production capacity is 6.4 million tons of iron ore pellets. Cliffs is expected to continue to grow through acquisitions, both domestically and internationally. A number of projects are currently underway at Wabush, which once completed, are expected to significantly lower cash cost per ton.
Cliffs is boosting its mining and transportation capacity globally. It has decided to commence the production of a lower silica, premium grade iron ore concentration product at the Bloom Lake iron ore operation in eastern Canada, which is expected to attract new customers and boost the mine’s profitability. Cliffs has also employed a global exploration program, which is aimed at identifying and capturing new world-class projects.
Cliffs acquired a 70% interest in energy company Renewafuel, a subsidiary of Endres Processing, Minnesota. This investment provides access to biomass fuel that may prove a suitable substitute for coal and natural gas used in iron pellet production, as well as a marketable product for other industries. Cliffs also acquired chromite assets in Northern Ontario, Canada from Freewest Resources, where it already held a 47% interest.Moreover, the company acquired full ownership of the chromite asset by acquiring Spider Resources, the smaller partner of the asset. Cliffs plans to start production at a chromite deposit in northern Ontario in 2015. A study of the area led the company to expand its output estimate to 1 million tons of chromite ore on top of the 600,000 tons of ferrochrome expected from the site. A longer-term potential diversification into chromium, which is sold to the stainless steel sector, could contribute about 29% of Cliffs’ total operating profits by 2015.
Cliffshas implemented a strategic capital allocation plan to ensure the optimum utilization of cash. Its focus remains on providing maximum return to the shareholders by way of dividend distribution while maintaining its organic growth pipeline. The company is also focusing on cost management amid a weak pricing environment, reflected by reduction in its SG&A and exploration coststargets for 2013 and cost reductions in its North American Coal operation.
REASONS TO SELL
Cliffs’ North American Coal segment is under pressure due to soft pricing for coal products. Moreover, the company is witnessing lower pricing for sea borne iron ore across the U.S., Eastern Canada and Asia Pacific, which hurt its results in the most recent quarter. Iron ore prices were depressed in the last few months due to the lack of a strong recovery in steel demand in China, the world's largest producer and consumer of steel, and a persistently oversupplied market.Excess capacity and weak Chinese demand has been a drag on commodity prices. The uneven balance between demand and supply is weighing on iron ore pricing.
International demand and economic conditions strongly affect the prices of iron ore and coal. The current uncertain macroeconomic environment, including the European sovereign debt crisis, may impact the company’s operations and its results.Moreover, demand for raw materials used in steel production is mostly driven by rapid industrial growth in China. International Monetary Fund (IMF) has cut its 2013 growth outlook for China to 7.75% from 8% on global economic weakness and insipid export demand. China’s GDP ticked down to 7.5% in second-quarter 2013 from 7.7% a quarter ago.Concerns are widespread that the world’s second-largest economy may continue to slither down.As such, if China witnesses decelerating economic growth rate for an extended period of time, demand Cliffs’ product will decrease, thereby impacting its sales and margins.
Substantial portions of Cliffs’ sales are made under term-supply agreements. More than 95% of the North American iron ore sales volume, the majority of the North American coal sales, and virtually all of the Australian sales were under term-supply agreements. For North American coal, these agreements typically cover a 12-month period and must be renewed each year. These contracts limit the ability of the company to raise prices to match international levels and fully capitalize on the strong demand for iron ore. The inability to increase prices or pass along increased costs could adversely impact margins and profitability.
Cliffs has a high customer concentration. Three customers - ArcelorMittal (Europe), Severstal (Russia) and Algoma (Canada) - accounted for 32% of its consolidated product sales and 62% of U.S. Iron Ore product revenues in 2012. The largest customer, ArcelorMittal, represented about 17% of total product revenues last year. This has a negative influence on product pricing and exposes the company to customer-concentration risk.
Capacity expansions within the industry could lead to lower global iron ore and coal prices, or it could impact production. Increased demand for iron ore and coal, particularly from China, led major iron ore and metallurgic coal suppliers to increase their capacity in 2009. Capacity increases could result in an excess supply of iron ore and coal, driving down prices. Such a scenario could adversely impact the company’s sales, margins and profitability.
RECENT NEWS
Cliffs' Earnings and Sales Beat, Net Slides – July 25, 2013
Cliffs posted second-quarter 2013 net earnings of $0.82 per share, down roughly 55% from $1.81 a year ago. Net income (attributable to common shareholders) declined 48% year over year to $133 million, hit by a decline in global iron ore prices and higher costs.
The results include $68 million asset impairment charges related to the write down of Cliffs' Amapa investment as well as income tax expense of $9 million. Barring one-time items, earnings of $1.13 per share topped the Zacks Consensus Estimate of $0.61.
Sales for the quarter came in at $1,488.5 million, down roughly 6% from $1,579.4 million in the prior-year quarter. But it exceeded the Zacks Consensus Estimate of $1,436 million. An 11% decline in global iron ore pricing led to reduced sales in the quarter.
Segment Performance
U.S. Iron Ore: U.S. Iron Ore pellet sales volume increased to 5.7 million tons in the quarter from 5.4 million tons in the second quarter of 2012. Higher customer demand and increased export sales related to pellet contracts led to the increased sales volumes.
Revenues per ton were down 8% year over year to $110.32 due to lower year-over-year market pricing for iron ore. The increase in volume exported into the seaborne market, which has lower realized pricing due to the increased freight costs, also led to the decline.
Cash cost per ton rose 8% to $67.59 due to increased costs related to the planned temporary production curtailments at Cliffs' Northshore and Empire mines as well as increased energy costs.
Eastern Canadian Iron Ore: Sales volumes in the reported quarter fell 18% year over year to 1.9 million tons. The lower sales volume was due to lower iron ore pellet availability from Wabush Mine.
Revenues per ton for the segment slipped 14% year over year to $110.66, due to decrease in seaborne iron ore pricing and the product mix which comprised of higher proportion of iron ore concentrate sales versus iron ore pellet sales. Cash cost per ton increased 7% to $114.43.
Asia Pacific Iron Ore: Sales volumes in the segment slipped 3% to 3 million tons due to the absence of sales volume from Cliffs' Cockatoo Island operation. Revenues per ton were $109.36, down 7% from $117.73 in the prior-year quarter, due to lower market pricing.
Cash cost per ton in the Asia-Pacific Iron Ore segment climbed 12% to $63.65 due to the absence of low-grade tons sold.
North American Coal: Sales volumes spiked 36% to 2.1 million tons, led by significantly higher sales volume from Cliffs' Oak Grove Mine and Pinnacle mines. Revenues per ton decreased 13% to $104.89, due to lower market pricing for metallurgical coal products.
Cash cost per ton decreased 20% to $88.12, due to lower maintenance and employment-related expenses and improved fixed-cost leverage from the increased sales volumes.
Financial Position
Cliffs had $263.3 million in cash and cash equivalents as of Jun 30, 2013, compared with $159.2 million as of Jun 30, 2012. Long-term debt stood at $3,323.3 million as of Jun 30, 2013, compared with $3,614.1 million as of Jun 30, 2012.
Outlook
The company lowered its full-year 2013 selling, general and administrative expenses guidance to roughly $215 million from its previous expectation of $230 million citing an overall focus on cost management.
Cliffs also decreased its full-year cash outflows expectation by $10 million to about $75 million for future growth projects. On the other hand, the company raised its outlook for capital expenditure and now expects to spend roughly $1 billion compared with its previous expectation of $800–$850 million. The revision is due to additional spending at Bloom Lake Mine related to tailings and water management.
U.S. Iron Ore Outlook
Cliffs reiterated its sales and production volume guidance of 21 million tons and 20 million tons, respectively for 2013. Cash cost guidance was maintained in the range of $65–$70 per ton.
Eastern Canadian Iron Ore Outlook
The company reduced its guidance for sales volume to 8-9 million tons from its previous expectation of 9-10 million tons. Production is also forecast to be in the range of 8-9 million tons. Lower volumes from Bloom Lake Mine related to lower than anticipated throughput and ore recovery rates led to the reduction in guidance.
Cliffs raised its full-year 2013 cash cost per ton guidance to $100–$105 from its previous expectation of $95–$100 due to additional mining expense that is expected to be incurred during 2013 related to the mine development of Bloom Lake's ore body.
Asia Pacific Iron Ore Outlook
For 2013, sales and production volumes guidance was maintained at 11 million tons. The outlook for cash cost per ton was lowered to $65-$70 from its previous expectation of $70-$75 mainly due to favorable foreign currency exchange rates.
North American Coal Outlook
For 2013, the company reiterated its sales and production volumes expectation for North American Coal which is expected to be around 7 million tons. Cliffs reduced its cash-cost-per-ton outlook to $90-$95 from its previous expectation of $95-$100. The company’s focus to improve the operation's cost structure led to the guidance reduction.
For the second half of 2013, Cliffs expects its two largest end markets to remain stable. The company expects modest growth in the U.S. economy, which is expected to support stable North American steelmaking utilization rates.
Cliffs' Earnings Tops, Sales Miss – April24, 2013
Cliffs posted adjusted earnings of $0.60 per share in the first quarter of 2013, down 29.4% from $0.85 earned in the year-ago quarter but ahead of the Zacks Consensus Estimate of $0.32. The adjusted earnings exclude a tax benefit of $0.06 per share.
On a reported basis, Cliffs’ earnings were $0.66 per share compared with $2.63 reported in the year-ago quarter. Weak iron ore pricing coupled with lower volume hurt Cliffs’ earnings in the quarter.
Sales for the quarter came in at $1,140.5 million, down roughly 5.9% from $1,212.4 million in the prior-year quarter and also missed the Zacks Consensus Estimate of $1,226 million. Decline in global iron ore sales volumes led to reduced sales in the quarter.
Segment Performance
U.S. Iron Ore: U.S. Iron Ore pellet sales volume decreased to 3.1 million tons in the quarter from 3.4 million tons in the first quarter of 2012. Lower volumes to a customer due to bankruptcy in May 2012 and seasonal shipping constraints on the Great Lakes led to the decline.
Revenues per ton were up 2% year over year to $119.82 due to customer mix and favorable provisional pricing settlement. Cash cost per ton fell 2% to $60.17 due to lower maintenance expenses.
Eastern Canadian Iron Ore: Sales volumes in the reported quarter were flat year over year at 1.9 million tons. Cliffs announced that it will idle the Wabush Pointe Noire Pellet Plant by the end of second-quarter 2013.
Revenues per ton for the segment jumped 13% year over year to $131.95, led by favorable provisional pricing settlements, lower freight rates and a 3% year-over-year increase in seaborne iron ore pricing.
Cash cost per ton fell 4% to $99.41, attributable to lower cash cost at Bloom Lake Mine primarily due to lower transshipping costs, reduced demurrage and lower contractor spending.
Asia Pacific Iron Ore: Sales volumes in the segment slipped 17% to 2.3 million tons due to vessel timing and the absence of sales volume from Cliffs' Cockatoo Island operation. Revenues per ton were $117.48, down 9% from $129.75 in the prior-year quarter, due to lesser revenue realizations due to lower iron ore grades as well as customer mix.