Assessing Cliffs’ Position after Its 2Q15 Results



Oversupply to pressure iron ore prices

Pressure should still remain on Cliffs Natural Resources’ (CLF) US Iron Ore, or USIO, and Asia Pacific Iron Ore, or APIO, segments—due to sustained iron ore weakness.

The structural nature of oversupply—due to capacity ramp-ups from major iron ore players, including BHP Billiton (BHP), Rio Tinto (RIO), Vale SA (VALE), and Fortescue Metals Group (FSUGY)—combined with weak demand growth from China should see continued pressure on iron ore prices in the foreseeable future. China (FXI) consumes two-thirds of the seaborne iron ore.

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To learn more about iron ore indicators, please read Long-Term Iron Ore Price Fundamentals: Tough to Love. The decline in seaborne iron ore prices could impact the pricing of the contracts, which come up for renewal in 2016. This would be negative for Cliffs’ cash flows. Currently, only USIO is generating cash. Asia–Pacific is also generating some cash, but it is directly impacted by seaborne iron ore prices, so its sensitivity is quite high.

Cliffs’ management is doing what is under its control, including cutting costs and selling non-core assets. However, the biggest factor impacting Cliffs—iron ore prices—is not under its control, which could mean further pressure on cash flows.

Question of debt remains

The question still remains whether Cliffs will be able to service its debt from its USIO segment alone. This is the only segment that management considers to be core. Management would like to operate it going forward. Structurally weaker seaborne iron ore prices should have a fallout impact on the US-realized iron ore prices, as we discussed previously in this series. At this point, the task seems daunting for the company.

Cliffs Natural Resources (CLF) forms 3% of the SPDR S&P Metals and Mining ETF (XME).


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