Better iron ore prices helped Cliffs Natural Resources (CLF -11.03%) earn $104.3 million of income in the third quarter, 23% more than a year earlier. The company's shares are still down 34% year-to-date, but, in my opinion, are poised to grow. Here's why.
Cost improvements
Cliffs Natural Resources demonstrated major improvements on the cost front. U.S. iron ore cash cost improved by 4.4%, while Eastern Canadian iron ore cash cost improved by 5.7%. Eastern Canadian costs remain elevated despite the progress. Cash cost at Canadian mines was $99.96 per ton, while it was just $64.81 in U.S. mines.
The met coal division saw dramatic improvements compared with the third quarter of 2012. Cash cost per ton dropped 34%. Cliffs stated that this significant decrease was mainly due to improved production volumes. However, low met coal pricing continues to put pressure on margins, and Cliffs lost money on its coal operations.
Coal accounts for 11.5% of Cliffs' revenue. The situation is worse for focused met coal producers like Walter Energy (WLTGQ), which has lost 55% of its capitalization this year. Besides the problem with low met coal prices, the company is very heavily indebted with more than $2.5 billion of debt on its balance sheet.
To pay portions of this debt, Walter Energy is obliged to take on even more debt. The recent $450 million bond offering is clearly not the last. Walter Energy slashed its dividend to a symbolic $0.01 per share, but in present conditions even such a small payment is excessive in my opinion.
New leadership
Since the current CEO's Joseph Carrabba retirement announcement, Cliffs did not make any strategic moves, waiting for the new leader. Now that Gary Halverson will take the newly created position of president and chief operating officer, the company can make important decisions.
Cliffs' strategic options are concentrated in the Canadian iron ore segment. Bloom Lake Mine is going through a Phase 1 expansion, and the decision about Phase 2 is on the table. The second phase of expansion will cost no less than $450 million, and Cliffs would ideally want to fund it from its operational cash flow. This will be a difficult task to accomplish.
The Wabush mine is remaining a high-cost producer, despite the cost-cutting progress. Cash costs at Wabush were $108 per ton, compared with $92 at Bloom Lake. The cost profile at Wabush must be improved, or the mine has to be divested. Now, with the new leadership, all options can be considered.
Iron ore is considered the place to be by many international miners like BHP Billiton (BHP 0.33%), which managed to grow its iron ore production by 23% from the third quarter of 2012. In addition to that, BHP Billiton is growing its met coal presence. BHP's met coal production increased by 14% in just one year. The company is betting on increasing demand from China, which is a main supportive force for resource prices.
As benchmark iron ore prices improved by 17% this quarter, Cliffs could bet on growing its iron ore production while continuing to improve costs. However, the company has $3.3 billion of debt on its balance sheet and wants to keep this figure closer to $3 billion. This target is not reachable without a further rise in iron ore prices.
Bottom line
Cliffs Natural Resources has shown good progress during the third quarter. Now, with the new president, the company is free to proceed in solving its Canadian iron ore puzzle. Whatever the company's strategic decisions will be, Cliffs would be better off with a fresh plan. As the world iron ore market seems to stabilize, Cliffs could make a good piece of your portfolio.
