Cliffs Natural Resources: Focusing on Turnaround Possibilities
It is not surprising to see that Cliffs Natural Resources (CLF) has lost over 57% of its value in 2015. The primary reason behind the company’s weakness can be attributed to weak iron ore pricing and demand, which is a result of an oversupply in the industry and an economic slowdown in China. In fact, in the past year, Cliffs has lost almost 83% of its market capitalization.
Now, if we go by the company’s latest results and outlook, it might seem that Cliffs is on its way to decline further. The company had missed Wall Street estimates by huge margins when it reported its second-quarter results at the end of last month.
A probable turnaround in the steel market could act as a catalyst
The influx of cheap Chinese imports of steel into the U.S. has hurt the local steel industry. For instance, the capacity utilization rate of steel plants in the U.S. so far this year stands at 72.5%, down from 78% in the prior-year period. As a result, it is not surprising to see why demand for Cliffs’ iron ore pellets, which are used in making steel, will remain weak this year.
However, in the long run, a recovery cannot be ruled out as an association of steelmakers in the U.S. is already looking to counter cheap steel imports from China. According to the Pittsburgh Post-Gazette:
“Five U.S. steel producers today filed trade complaints over steel imports from China and seven other countries, alleging they were injured by unfairly priced imports that were, in some cases, government-subsidized.
The trade cases were filed by U.S. Steel, AK Steel, Nucor, Steel Dynamics and Arcelor Mittal. They are asking that tariffs of up to 320 percent be imposed on imports of certain types of steel from those countries.”
According to the World Trade Organization, “Dumping, or selling abroad below the cost of production to gain market share, is illegal…and is punishable with tariffs.” As a result, I won’t be surprised if heavy duties are imposed on Chinese imports of steel going forward if we go by an existing precedent. Last year, U.S. steelmakers won a dumping case related to cheaply-priced imports of OCTG products.
Now, in the current scenario as well, I believe that the decision could be in favor of U.S. steelmakers as the industry has indeed suffered due to cheap imports. As already mentioned, utilization rates have dropped at an alarming pace, while steelmakers such as U.S. Steel (X) are posting huge losses due to cheap imports. This is despite the fact that the automotive and construction markets in the U.S., which are among the key users of steel, have remained strong in the past year.
Thus, the imposition of duties on imports will make imports costlier, leading to an improvement in capacity utilization in the U.S. This will, in turn, have a positive impact on iron ore demand going forward, and help Cliffs make a comeback.
China could also be a catalyst
Another factor that could help Cliffs make a comeback in the long run is the expected improvement in iron ore demand in China. Although there are concerns regarding China’s economic growth, we should not ignore that urbanization is fast gathering pace in the country. In 2002, there was 36% urbanization in China, and the number is anticipated to increase to 70% by the end of 2050. This means that China’s urban population will increase by around 300 million to 700 million during this time period.
Now, this will lead to an increase in infrastructure demand such as telecom, housing, roads, and auto. As a result, demand for steel in China will rise going forward, ultimately leading to higher iron ore requirements. Moreover, it is likely that the country will use its steel domestically rather than export it due to increasing infrastructure demand. In fact, China’s steel output is expected to rise to 1 billion tons in 2030 from 823 million tons in 2014, which is not surprising if we keep in mind rising infrastructure demand in the country.
Thus, the increase in iron ore demand in both the U.S. and China in the long run will act as a catalyst for Cliffs.
As discussed above, there is a likelihood that iron ore pricing will improve in the long run as demand improves and the oversupply situation in the industry eases. Thus, these two macro factors could help Cliffs improve its shipment figures going forward as against a weak performance this year.
More importantly, as I will discuss in my next article, Cliffs is making adjustments to its business in order to stay afloat in a difficult iron ore pricing environment. When coupled with improving iron ore prospects, there is a probability that Cliffs will be able to make a comeback in the long run.