What's Dragging Down Cliffs Natural Resources?

Cliffs Natural Resources' (NYSE: CLF  ) second-quarter report was long awaited amid pricing headwinds and a proxy fight with activist investor Casablanca Capital. Cliffs Natural Resources managed to surprise analysts, reporting a loss of just $0.01 per share vs expectations of a loss of $0.08 per share. However, there's little optimistic news in the company's second-quarter report.

No mercy from pricing
Only Cliffs' U.S. iron ore segment managed to sell its production for more than $100 per ton. There is no surprise in this fact, as Cliffs' U.S. iron ore segment is more protected from price downside because of long-term contracts with customers like ArcelorMittal (NYSE: MT  ) and AK Steel (NYSE: AKS  ) .

The pricing situation is far worse for Eastern Canadian iron ore and Asia Pacific iron ore segments. Eastern Canadian iron ore sold its production for $87.48 per ton, while Asia Pacific iron ore was sold for $80.38 per ton. The ore from Australia is priced that low thanks to the efforts of Rio Tinto (NYSE: RIO  ) and BHP Billiton (NYSE: BHP  ) .

Rio Tinto's iron ore shipments rose 23% in the second quarter of this year compared to last year's figures. In turn, BHP Billiton grew production by 20%. What's more, both giants are going to expand further. Rio Tinto's CEO Sam Walsh has recently stated that he is confident in demand from China, and that Rio Tinto easily sold everything that it produced. Rio Tinto's confidence is no good news for Cliffs Natural Resources, as the latter needs improvements on the price front. These improvements will not materialize if Rio Tinto and BHP Billiton continue to flood the market with cheap iron ore.

Bloom Lake and met coal remain a headache
The costly Bloom Lake mine remains a major headache for Cliffs Natural Resources. Second-quarter cash costs in the Eastern Canadian iron ore segment were $87.48 per ton – exactly the same as the sales price. Add costs of depreciation and amortization of $19.36 per ton and you get a hefty negative sales margin.

What's more, in current conditions Cliffs Natural Resources is not proceeding with the mine's phase II expansion – and this costs as well. In the second quarter, the company had to record a $14 million penalty incurred from not meeting a minimum tonnage rail shipment contract because of the mine's expansion delay.

North American coal segment is an even worse performer, with cash costs of $83.01 per ton and a sales price of $72.84 per ton. Cliffs Natural Resources decided to idle its Pinnacle mine from August 25, but it does not seem that this move will be of great help for the troubled segment. However, better late than never.

Shipping delays hurt outlook
Harsh winter weather still impacts producers. Shipping delays resulted in a revision of U.S. iron ore segment sales outlook. Now, Cliffs Natural Resources expects to sell 22 million tons of iron ore, which is at the low end of the previous 22 million-23 million expectation. This is negative, as U.S. iron ore segment is the healthiest part of Cliffs.

Meanwhile, the troubled Eastern Canadian iron ore segment will have production and sales at the high end of the previously indicated 6 million-7 million range. From a big picture point of view, one million tons of U.S. iron ore are "exchanged" for 1 million tons of Eastern Canadian iron ore, and this costs more than $19 million because of the sales price difference. The difference in cash costs adds another $21 million, if we assume that cash costs will stay the same as in the second quarter.

The bright spot is that the cash-positive Asia Pacific segment will reach the high end of its 10 million-11 million production guidance, while the cash-negative North American coal segment will produce less coal because of the idling of the Pinnacle mine.

Bottom line
Although Cliffs Natural Resources' second-quarter results beat analysts' expectations, there's no reason for celebration. The situation remains tough, and the company needs drastic measures to make a turnaround. 

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