When the prices for a company’s products fall, the two ways to improve profitability are to increase volumes or reduce costs. When demand is weak, it’s not possible 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’s (CLF) cost-cutting efforts in relation to its US Iron Ore or USIO and Asia-Pacific Iron Ore or APIO divisions in 2016 as well as its 2017 cost outlook.
Cost progression in APIO
In 4Q16, Cliffs’ cash costs of goods sold for APIO was $36.4 per ton, or 8% higher YoY (year-over-year). When compared to 3Q16, the unit costs were 7.5% higher in 4Q16. The increase in costs was mainly due to higher royalties and an unfavorable exchange rate. The higher costs were also attributable to increased mining and haulage costs as Cliffs’ operating footprint expanded.
However, as far as cash costs are concerned, the segment remains disciplined, with costs down $3 per ton or by 8%. Cost reductions in the seaborne iron ore market aren’t limited to Cliffs Natural Resources. Iron ore majors such as BHP Billiton (BHP) (BBL), Rio Tinto (RIO), and Vale (VALE) also benefit from the exchange rate and other cost reductions.
The company guided for cash cost of goods sold of between $34 and $39 per ton. This guidance is based on the average exchange rate of $0.75 US dollar (UUP) to the Australian dollar.
Investors should note that this guidance is higher than the company’s 2016 actual costs of $34 ton. Higher costs are mainly due to higher expected royalties and increased mining and haulage costs. This is mainly due to the fact that Cliffs’s continue to expand its footprint.
Unit cost progression in USIO
Cliffs’ cash cost of goods sold production costs for 4Q16 came in at $52.80 per ton, 8% lower YoY and sequentially. This was mainly driven by the absence of idle costs and a supplies inventory write-off that was incurred in 4Q15.
During the 4Q16 earnings call, CEO Lorenco Goncalves mentioned that in the US business, they cut “cash cosmetics” by another $4 per ton. CLF’s management guided for the cash cost of goods sold and operating expenses between $55 and $60 per ton, as compared to $56 per ton in 2016.
The expected costs in 2017 should be almost constant as compared to 2016, despite the company having introduced a more specialized pellet into the production mix.