US iron ore segment
Cliffs Natural Resources’ (CLF) US iron ore segment produces various grades of iron ore pellets. Cliffs’ customers use the pellets in blast furnaces as part of their steelmaking process.
Cliffs’ US iron ore (or USIO) segment operates through five iron ore mines located in Michigan and Minnesota. Cliffs sells iron ore mainly to integrated steel companies in the United States and Canada pursuant to long-term supply agreements. Cliffs’ major customers are steelmakers such as ArcelorMittal (MT) and AK Steel (AKS).
Contract renegotiation a risk
Due to long-term contracts, US iron ore operations are less prone to the benchmark, China’s cost and freight (or CFR) price. However, due to a prolonged supply glut and a weak demand situation, contract renegotiations could pose a big margin risk.
One of Cliffs’ major contracts with ArcelorMittal (MT) is coming due for renegotiation in December 2016. In 2014, ArcelorMittal constituted 40% of the revenue for Cliff’s iron ore division. Given weakening iron ore prices globally and the eroding bargaining power of suppliers, the contract could be renegotiated at significantly lower prices. This could be a negative for the company.
Question of competition
Competition in the domestic market doesn’t seem to be a big risk right now for Cliffs Natural Resources (CLF). U.S. Steel (X) will temporarily idle its iron ore plant in Keetac, Minnesota, from May 13, 2015. This is due to adjustment of production to weak demand conditions. Its annual rated capacity is 5.4 million tons.
Magnetation is ramping up Cliffs’ pellet plant with an annual capacity of 3.0 million tons. It will supply all the production to AKS. This production, even if it comes on line, will not be a threat to Cliffs’ volume sales to AKS. Any lower than 3.0 million tons could be a slight upside to Cliffs.
The threat of competitors from neighboring areas is limited since the break-even cost of any competitor trying to enter the North American market from Brazil or Eastern Canada is prohibitive.
However, the current depressed price environment for steel and iron ore doesn’t bode too well, even for USIO, the crown jewel of Cliffs.
The SPDR S&P Metals and Mining ETF (XME) has ~35% exposure to steel plays. It could be an alternate way to play the steel industry for investors who want to avoid the hassles of picking individual stocks.
Cliffs Natural Resources’ (CLF) US iron ore segment is relatively immune to the seaborne market. But let’s see how the Asia-Pacific division is doing. This division is fully exposed to the vagaries of seaborne iron ore trade.