When the prices for a company’s products fall, the only way to improve profitability is to either increase volumes or reduce costs. In a weak demand scenario like what we have now, it’s impossible to drive higher volumes beyond a point. This barrier leaves cost reduction as the only source of margin expansion.
In this context, we’ll discuss Cliffs Natural Resources’ (CLF) cost-cutting efforts in relation to its US iron ore (or USIO) and Asia-Pacific iron ore (or APIO) divisions.
Cost reduction in APIO
- The cash production cost for APIO was $28.5, down 17% year-over-year. Compared to 1Q16, costs were up 6%—mainly due to the headwind from the Australian dollar exchange rate.
- Because of lower YoY costs, despite lower seaborne prices, the division was able to generate its highest EBITDA since 2014.
- The company maintained its 2016 cash production cost guidance for APIO at $25–$30 per ton and its cash cost of goods sold guidance at $30–$35 per ton. This is based on an assumption of the Australian dollar (UUP)(USDU) exchange rate of $0.75.
- Cost reductions in the seaborne iron ore market aren’t limited to Cliffs. Iron ore majors, including BHP Billiton (BHP)(BBL), Rio Tinto (RIO), and Vale SA (VALE), are also benefitting from the exchange rate and other cost reductions. To learn more about this trend, please read Cost Deflation Could Prolong the Pain for Iron Ore Miners.
Cost reduction in USIO
- Cliffs Natural Resources delivered a better-than-expected cash cost reduction in USIO with cash production costs of $46 per ton in 2Q16, which is a 17% reduction year-over-year. It’s also lower than the guidance of $50–$55 per ton for 2016.
- Management attributed this reduction to improved maintenance practices and reduced repair expenses, lower diesel and natural gas prices, and reduced labor expenses.
- Despite better-than-expected costs, management maintained its cash production costs at $50–$55 per ton and its cash cost of goods sold guidance at $55–$60 per long ton.
- The expected cash cost of goods sold includes an expected idling costs of $55 million, which is lower than the previous estimate of $65 million in idling costs. This reduction is due to earlier than expected restart of Northshore and United Taconite mines.