At first glance, Cleveland-Cliffs' (NYSE:CLF) most recent earnings report might make shareholders want to push the sell button as fast as they can open their brokerage accounts. But before you precipitously sour on this iron miner, take a deeper look at its results. Even though its revenue and earnings were down drastically, those declines were largely a product of its moves to shut down unprofitable assets.
If you are a Cleveland-Cliffs' investor, there are a few numbers in this earnings release that should give you a lot of hope for the upcoming year and beyond. Here's a brief rundown of its most recent earnings report.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017|
|Revenue||$239 million||$600.9 million||$461.6 million|
|Operating income||($40.0 million)||$105.3 million||$80.1 million|
|Net income||($84.3 million)||$317.8 million||($28.1 million)|
Under most circumstances, such a drastic reduction in revenue and widening losses would rightly be viewed as a cause for investors to panic. This is probably one of those rare instances that those numbers don't tell the whole story -- in this case, because of two items that significantly impacted Cleveland-Cliffs' income statement for the first quarter.
- Changes to its accounting standards and taxes: Under the new rules, revenue is recognized when customers receive delivery of iron ore. From here on out, this will reduce the amount of revenue recognized in the first quarter, because many of the locks and canals Cleveland-Cliffs uses to move its product are frozen during that period of the year. Conversely, quarterly revenues will be higher during the remainder of the year. Also, the company took a $16 million charge related to the IRS's decision to sequester any refundable alternative minimum tax credits.
- Ceased mining operations at its Asia-Pacific Iron ore division: Returns have slowly diminished over the years at Cleveland-Cliffs' Australia mining complex as costs increased and the lower quality iron ore it contains becomes less attractive to its buyers in China. Management elected to stop all mining activities and ship out the remaining inventory before reclassifying it as a "discontinued operation" in the second quarter. This also resulted in a $47 million impairment charge for mine closure activities.
When you factor those two things out of its most recent results, the picture looks less bleak. In fact, one thing that was incredibly encouraging was the performance of its U.S. iron ore business.
Even though the company reported a near 50% decline in tons sold as a result of those new accounting standards mentioned above, Cleveland-Cliffs still reported a higher gross margin compared to this time last year. Several new contracts that have new pricing models led to a 32% increase in the average price per ton sold. Since most mine costs are fixed, those higher prices flowed straight to the bottom line, and produced a $38.17 per ton gross margin compared to $15.72 year over year.
What management had to say
The Q1 headline numbers in Cleveland Cliffs certainly didn't dampen the enthusiasm of CEO Lourenco Goncalves. In his press release statement, he touted the strength of the company's U.S. iron ore business.
The year started very well for our pellet business, with better-than-expected performance for both tonnage shipped and price realization. The Great Lakes ice melting earlier than forecasted has helped our blast furnace clients to start a much-needed replenishing of their depleted pellet inventories ahead of their own expectations. To illustrate its strength thus far, we outperformed our EBITDA from last year's first quarter in U.S. Iron Ore, despite only recording about half the sales volumes ... The strength in the domestic steel market we have seen so far this year is sustainable and should support very strong results for Cleveland-Cliffs in 2018.
Speeding with the emergency brake on
Closing less profitable mines from time to time is simply part of the mining business. Management had been saying for several quarters that it would run the Australian mining complex as long as it remained a positive cash flow asset. That was no longer the case, as the price for its lower-grade iron ore has declined drastically in recent quarters, so its closure should come as no surprise to investors.
It does mean, though, that Cleveland-Cliffs' results will get dragged down slightly by mine closure costs and by the termination of some of its service contracts. Fortunately, there's robust demand for iron ore, and high prices in the U.S. that should more than offset these costs, and lead to some of Cleveland-Cliffs' best results in years. As long as the miner maintains this track, its shareholders should be richly rewarded.