It has been nearly a year since Casablanca Capital, an activist hedge fund, took over control of Cliffs’ board and management after a protracted proxy contest with the previous management. In July of last year, Casablanca Capital had pointed to the massive 85% loss in Cliffs’ stock price over the previous three years when making a case for a change in management. However, the company’s stock price has fallen another 65% over the past year, as shown below.
However, the company’s stock price over the past twelve months has plummeted largely because of externally imposed factors, rather than the decisions of the management itself. In this article, we will look at what steps the new management has taken since it took over, and why these measures have not had an appreciable impact. Before that, we will take a look at the externally imposed factors weighing on Cliffs’ stock price.
Iron Ore and Coal Prices
Iron ore and metallurgical coal are important raw materials for the steel industry. Thus, demand for these raw materials by the steel industry plays a major role in determining their prices. Though a majority of Cliffs' iron ore sales are to the North American steel industry, sales agreements are benchmarked to international iron ore prices. International iron ore prices are largely determined by Chinese demand, since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. Chinese steel demand growth is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014. Weak demand for steel has indirectly resulted in weak demand for iron ore.
On the supply side, an expansion in production by major iron ore mining companies such as
Iron Ore Prices, Source: Y Charts
China is also the largest consumer of metallurgical coal in the world. Demand for the commodity by the Chinese steelmaking industry has been weak, adding to subdued demand from other major consumers such as Japan and the EU. Weak demand coupled with an oversupply situation, due to an expansion in production by major mining companies, has resulted in plummeting coal prices. This has negatively impacted Cliffs' North American Coal business, which primarily sells metallurgical coal, whose prices are linked to prices of Australian metallurgical coal. Benchmark metallurgical coal prices currently stand at around $90 per ton, nearly 70% off the levels of $300 per ton seen in 2011. In view of the oversupply situation, metallurgical coal pricing is expected to remain subdued in the near term.
Major Steps Taken by Cliffs’ Management
After Casablanca Capital took control of Cliffs’ management, the company has reoriented its strategic focus towards its U.S. Iron Ore operations. Cliffs’ U.S. Iron Ore operations remain the company’s most profitable operating unit. Pricing contracts for the U.S. Iron Ore operations are longer term and are not as closely linked to international iron ore spot prices, when compared with pricing arrangements for Cliffs’ international iron ore mining operations. The U.S. Iron Ore operations also have the lowest production costs, and a combination of low costs and favorable pricing arrangements has meant that the U.S. operations remain profitable even under the current pricing environment. All of the company’s other operations, namely its Canadian Iron Ore operations, its Asia-Pacific Iron Ore operations, and its North American Coal mining operations were potentially available for sale after Casablanca Capital took over, provided that the company could attract buyers for the same.
Cliffs’ management eventually suspended operations at the company’s high-cost Canadian iron ore mining operations. The Canadian unit later filed for bankruptcy protection. Apart from suspending operations in Canada, Cliffs’ management also managed to selectively divest some of its coal mining assets. Cliffs sold off its Logan County Coal assets towards the end of 2014, which accounted for nearly 23% of the company’s metallurgical coal production of 6.6 million tons, and all of its thermal coal production of 0.6 million tons in 2013. [9] In addition, in order to adapt to the low commodity pricing environment, Cliffs lowered its capital expenditure to $284 million in 2014 from $861 million in 2013, and expects to further reduce this to $100-125 million in 2015. The company further instituted measures to reduce operating costs.
However, despite the management’s efforts, the sharp fall in commodity prices has taken its toll on Cliffs’ businesses. The coal mining operation reported operating losses, whereas the sales margin for the Asia Pacific Iron Ore business, which is a measure of the segment’s operating income, fell from $25.11 per ton in Q1 2014 to $0.26 per ton in Q1 2015, with cost savings partially offsetting the impact of a decline in realized prices, which fell over 50% year-over-year. In addition to the fall in iron ore prices, the company’s U.S. Iron Ore operations have been negatively impacted by a fall in domestic steel production, due to competition from cheap steel imports. Lower domestic production has led to a decline in demand for iron ore, with Cliffs revising down its U.S. Iron Ore shipment guidance for 2015 by 7%.
See our forecasts for U.S. Iron Ore Shipments
Thus, though the steps taken by the management have helped make incremental improvements to Cliffs’ operations, the external pricing environment has had an overwhelmingly negative effect upon Cliffs’ operations. The management has done well to focus on its profitable U.S. Iron Ore operations, while looking at ways to offload its other operations. This has positioned the company to operate more competitively in a low commodity pricing environment, and will ensure that the company can rapidly boost its profitability when iron ore pricing improves. However, the fate of the company remains tied to the externally imposed pricing environment. This has primarily been responsible for the company’s woes, and is unlikely to improve substantially in the near term.
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