The price of iron ore is collapsing. Unless it rapidly reverses its course, Cliffs Natural (NYSE:CLF) is not going to be around for long.
Iron ore troubles
Goldman Sachs believes that the price of iron ore could fall to a low of $80 per ton by the end of this year. This would be a near 40% drop from the high of approximately $140 per ton reported last year .
If the price of ore were to reach this level, it would be a disaster for Cliffs. Cliffs is a relatively high-cost iron ore producer.
For example, the company reported that during the fiscal first quarter, its cost of production per ton of ore at its Canadian operations was $129.4, including depletion and amortization. This gives a sales margin of just under -$31 per ton.
Additionally, the total cost of ore produced within the Asia Pacific region was $71 per ton, giving a sales margin of $25 per ton. Within the U.S., the total cost of production per ton was just under $76, giving a sales margin of $34 per ton.
It doesn't take much work to figure out that Cliffs, in its present state, is highly sensitive to a falling iron ore price.
Drowning in Bloom Lake
But a falling price of iron ore is not Cliffs' only problem. The company is facing multiple other headwinds, the most persistent of which is Bloom Lake. There are also plenty of new competitors starting up within the Great Lakes region (which is depressing prices), and the company's Australian assets are rapidly depleting.
Wall Street sees the issue of Bloom Lake overhanging Cliffs' shares until a resolution is found. Casablanca Capital, the activist investment fund trying to instigate change at Cliffs, sums up the Bloom Lake debacle:
In 2011, Cliffs paid $4.9 billion to acquire the largely undeveloped Bloom Lake project in Eastern Canada. It has since spent approximately $1.5 billion on development and sustaining capex ... if Cliffs moves forward with the project, it estimates another $1.25 billion will be needed to complete the critical Phase II, while take-or-pay and production penalties ($60 – $80 million per year) will persist if the project is halted ... our analysis indicates Cliffs currently trades with a negative $2 billion value drag from Bloom Lake.
Smaller peers could disappear
Iron ore industry giant Rio Tinto (NYSE:RIO) has weighed in on the state of the iron ore industry. The company's management has stated that if the price of iron ore does fall to the $80 per ton level, many smaller peers will disappear. I don't want to speculate too much, but I would be willing to say that Cliffs could also disappear if the price of ore fell below that level.
However, Rio is not worried. You see, although $9 out of every $10 in profit Rio Tinto generates is from the production and sale of iron ore, the company is an extremely low-cost producer. At present, Rio's cost per ton is around $20, as compared to the current price of $90 per ton.
Nevertheless, it is possible that Rio is planning to drive smaller peers out of the market. Despite the fact that the iron ore market is oversupplied and prices are falling, Rio is still planning to up output to 290 million tons per annum this year, followed by 360 million tons in the near future.
Cliffs has many problems on its hands. However, the most important appears to be the price of iron ore. Cliffs is a high-cost iron ore producer, and a further decline in the price of the commodity is likely to hit Cliffs hard. The company's other problem is Bloom Lake, which it needs to find a solution to soon.
Rio Tinto, on the other hand, is not worried about a falling iron ore prices. Rio is a low-cost producer and is planning to ramp up output over the next few years, which should depress costs even further.