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’ (CLF) cost-cutting efforts in relation to its US Iron Ore (or USIO) and Asia-Pacific Iron Ore (or APIO) divisions in 1Q17, as well as its 2017 cost outlook.
Cost progression in APIO
In 1Q17, Cliffs Natural Resources’ cash costs of goods sold for APIO was $37.30 per ton, or 15% higher YoY (year-over-year). When compared to 4Q16, its unit costs were 2% higher in 1Q17. The increase in costs was mainly due to higher royalties, increased mining costs due to a higher strip ratio, and an unfavorable exchange rate.
Cost optimizations 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 the cash cost of goods sold between $34–$39 per ton. This guidance is based on the average exchange rate of $0.75 (UUP) to the Australian dollar.
Investors should note that this guidance is higher than Cliffs Natural Resources’ 2016 actual costs of $34 ton. Higher costs are mainly due to higher expected royalties and increased mining and haulage costs, mostly because the company continues to expand its footprint.
Unit cost progression in USIO
Cliffs Natural Resources’ cash cost of goods sold (or COGS) and operating expenses for 1Q17 came in at $58.60 per ton, which was 7% lower YoY. The improvement in costs was primarily driven by the absence of idle costs in 1Q17.
CLF’s management maintained its guidance for its cash cost of goods sold and operating expenses between $55–$60 per ton, compared to $56 per ton in 2016.
In the next part of this series, we’ll see how Cliffs Natural Resources with respect to its debt reduction is concerned.