After posting fourth quarter results that were well received by Wall Street, management at Cliffs Natural Resources (CLF 2.07%) had some sharp words for the industry, as has been the case ever since new management took over a couple years ago. Not only did management tout its efforts to reduce debt and make the company a better operator in the iron ore business, management also talked about some important developments in the industry as a whole that any investor with a stake in the iron ore and steel making business needs to know.
Here are several quotes from Cliffs' most recent conference call that give a pretty good summation of how management sees the industry and the company itself evolving over the coming years.
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The insurmountable issue is looking surmountable
It was only a couple years ago that Cliff's debt load looked like it was going to eventually sink the company. What's even worse was the assets purchased with that debt were wildly unprofitable. That was then, this is now. As part of new CFO Tim Flanagan's statement, it looks as though Cliffs has put itself into a position such that fears of insolvency are behind it.
The ultimate goal remains a bulletproof balance sheet that can withstand the inherent cyclicality in our business. This strategy has worked very well and much progress has been made, but we are not done yet. With that in mind, our focus on debt reduction and maturity extension will continue to be front and center as I begin my tenure as CFO. As I move to the discussion of our financials, I will lead with this very topic. Our net debt as of year-end was $1.8 billion, over $600 million reduction from last year, and our lowest recorded level of net debt since early 2011. Consistent with our priorities as well as what we've voiced throughout 2016, reducing our debt balance has been our #1 focus, and I can happily say that we've beat even our own aggressive targets.
Iron ore returning to normal (if there is such a thing)
Cliffs' CEO Laurenco Goncalves is definitely in the running for CEO that is least afraid to speak his mind. Every quarter his statements on the iron ore market are both acerbic and enlightening. Here's Goncalves' most recent statement on the state of the iron ore industry today and what it means for Cliffs and other miners.
The most important point I would like to make today, we finally have sanity back in the seaborne iron ore market. I truly commend Rio Tinto and Vale for eliminating the reckless behavior that had infected the market for a number of years and destroyed several billions of dollars in equity value.
Once the market analysts saw iron ore prices at $40, they believed that this was the new norm. Not the case. For a controlled commodity like iron ore, in which only 3 big players have the ability to move market price up or down, this should never be the case. Iron ore at $40 is not nor will it ever be norm. The so-called experts defending this figure as a possible scenario or even worse as a sure thing should have learned a tough lesson between January 2016 and January 2017. Iron ore prices increased month after month after month during 2016. Please check the actual curve. Furthermore, in January 2017, 62% Fe content iron ore price averaged $81 per metric ton, $81 spot 0 weight to be precise. As of today, the same 62% Fe content iron ore price is $84...
...Since the adoption of a more rational behavior by Rio Tinto after the departure of its former CEO, they added 2 major producers. Vale and BHP [Billiton] followed suit and also adopted a more disciplined approach to selling iron ore. Vale, for example, has made it abundantly clear that they have no intention to flood the international market with more iron ore than the market can absorb. And that S11D [a mine under development by Vale], despite being a very high grade ore, is construed as a replacement mine. We expect this type of responsible behavior to carry on, which will continue to support strong iron ore prices and bear fruit for not only the 3 majors, but also for Cliffs.
High inventories are a red herring
One thing that consistently gets pointed to as a bearish case against iron ore is the high levels of iron ore inventory in China today. The theory is that, as the worlds largest manufacturer of steel, companies there drawing down inventory instead of buying iron ore would cause iron ore prices to slump again.
One thing that Goncalves pointed out is that it's not so much the size of the inventories that matter as much as the type of inventory that is being held:
We have also encountered some new dynamics in the Chinese market. Between the improved profitability of the Chinese steel mills, the elevated prices of coking coal, and most importantly, the increasingly serious crackdown on pollution is sponsored by the Chinese government, demand for higher grade iron ore has risen significantly.
As a consequence, low-grade 56% iron content ore is having a tougher time to find a home with good clients. This is evident as we observed the wider spread between the 62% Fe reference price and the price of low iron content ore. Previously, when the Chinese mills were not being forced to pay attention to pollution and coking coal prices were extremely low, iron content didn't matter. Now it does matter. And that's why we continue to see high iron ore inventories at the ports. The stock accumulated in port sites is not the good ore. It is pollution-heavy, low-iron-content material. In sum, this port stocks could stay high or even go further up and that will continue to have a very limited influence on the 62% iron ore price index.
This is one of those kind of topics that some beginner investors might not consider when looking at the iron ore market. The type of iron ore does matter. If pollution control really does become the priority that China's government has claimed it to be, then it's entirely possible that those large stockpiles of low grade iron ore will not get used.
An unspoken benefit of a Trump presidency
Most Wall Street analysts out there talking about the benefits of a Trump presidency have pointed to corporate tax rates and stricter trade policies. What Goncalves is hoping for, though, is that the new administration will crack down on companies that are skirting around current trade regulations.
A number of steel buyers within the boundaries of United States, including but not limited to, distributors and service centers, have built their respective business on being the final recipients of illegally traded steel. With that, they benefit from an unfair advantage against other steel buyers and service centers that play by the rules.
Nobody had any doubts that buying stolen goods is illegal. Well, buying dumped steel should be seen as it is. And it is also illegal. We fully expect that the renewed emphasis on enforcement of trade cases to be implemented by the Trump administration will soon result in identifying and punishing the recipients of illegally traded steel. From now on, I will devote a lot of time and effort to get these downstream folks treated the way they deserve. I believe that fighting for a level playing field in the U.S. market is a fight worth fighting and that the rule of the law must prevail and be enforced all the way downstream in the supply chain. At this point, I have no doubt that with the focus of the Trump administration on legal trade and full enforcement of our trade laws, we will be able to catch at least some of the bad players among the buyers of illegal steel, making them a clear example to the ones that were lucky enough not to be caught.
Several of Trumps cabinet picks have been involved in the steel industry for some time, and understand the dynamics of the market. As with everything President Trump, it's too soon to tell if this actually will happen.
The future of Cliffs
Slowly but surely, the U.S. steel making industry has been shifting from the traditional blast furnace model to more modern techniques such as using electric arc furnaces and direct reduced iron rather than typical fines or pellets. One analyst on the call asked Goncalves about the possibility of supplying the U.S. market with Direct reduced iron grade pellets, specifically to Nucor's (NUE +2.73%) facility in Louisiana. Here's what he had to say on the topic:
DR grade pellets for us is our future, and we continue to develop the product. We'll continue to produce and sell to our well-established clients. And that's Nucor, Trinidad. From the logistics standpoint, due to the design of the unloading block at Nucor, Louisiana, we can't get there by rail. And it's impossible to get there through the sea, because there is a thing called Jones Act... But departing from the United States and arrive in Trinidad is viable. This being said, we continue to do business in Trinidad. We are very happy with the development and relationship with Nucor. They'll always be my preferred client for DR grade pellets because they -- when nobody knew what we'll be doing, they trusted us, and I really appreciate the support I got from John Ferriola, Joe Stratman and all the people at the plant. And our people worked very well with them to develop a product that now we are selling to another client, that's ArcelorMittal (MT +3.94%) Canada. We just started doing business with them. So if the stock is small, like these things always stock, but ArcelorMittal Canada wants 2 DRI facilities, and we are going to start supplying them soon.
Cliffs is making the right moves: It's getting its balance sheet back into fighting shape, and positioning itself to better serve the needs of the North American steel industry with its investments in direct reduced iron. While there are some logistical challenges, Cliffs is in much better shape to serve the current and future needs of the steel industry.
