The Rising Influence of Rising Affluence

[DewDiligence]

Revisiting CLF’s chromite assets in Ontario:

Thanks to dewophile for catching the increase in anticipated cap-ex for CLF’s chromite project in Ontario to >$3B, as set forth in the PR issued on 1/19/12. Although I posted the PR in #msg-71102089, I missed the detail that the potential chromite expenditures had ballooned from the original $1B estimate at the time of the acquisition in Nov 2009 (#msg-43909449). The ballooning of these expenses came up on CLF’s 4Q11 CC last week, and the answers were not entirely satisfactory, IMO:

http://seekingalpha.com/article/372341-cliffs-natural-resources-ceo-discusses-q4-2011-results-earnings-call-transcript

Michael F. Gambardella (JPM): I have a question on the chromite project… I thought when you initially purchased the properties, the estimated capital cost to develop the property was about $1 billion or less than $1 billion. And most recently, I think you were around $3 billion now, maybe even higher with the roads. Can you comment on that? And the change and the scope of the project, inflation on the cost, what's changed so dramatically?

Joseph A. Carrabba (CEO): Initially, we did go out with $1 billion price tag for this project and we are [now] in about the $3.3 billion range. I think what's really happened is, one, the sharpening of the estimate as we go through prefeasibility. And we are not through prefeasibility. So we expect to cross that line in May, June. We're going to stay in prefeas as long as we need to and get the appropriate work done to try and get this thing framed up. So we'll have an even better number on that. But as you know, when you come out with these numbers initially, they've got a wide plus or minus 30% or 40% onto your side. I think the second thing, certainly, is the transportation on the road. It has gotten more expensive in this segment than we expected.

Michael F. Gambardella (JPM): Right. But your internal take on the returns on this project on $1 billion cost versus $3 billion plus cost must have changed dramatically. I mean, is this still a viable project?

Laurie Brlas (CFO): Yes, sure, Mike. They definitely have changed, but at this point, it is absolutely still a viable project with a return that exceeds our cost of capital. And at every phase along the way, we will continue to evaluate that.

Joseph A. Carrabba (CEO): …the original project scope was just built around about 600,000 tons of ferrochrome. We've also added about 1 billion tons of chrome concentrate to the design of the volume that we'll do. So the economics around the project have changed somewhat, too.

Perhaps the skepticism I expressed about the chromite deal at the time of the acquisition was well founded after all; in #msg-43909449 (from Nov 2009) I said:

…the cost to bring the acquired mines into commercial production will be enormous and I think CLF is overestimating its ability to pull off a project of this magnitude. …this project sounds like a black hole of delays, cost overruns, and forays into the capital markets.

I also commented on this in #msg-50560331 (from May 2010):

The Ring of Fire project is going to require a huge amount of capital and expertise to commercialize, and it doesn’t leave much margin for error if the global economy turns soft again.

Despite all this, CLF is one of my favorite natural-resources stocks: it’s an increasingly prominent participant in The Global Demographic Tailwind, the valuation is dirt cheap, and it has buyout vig (#msg-71869156). However, I think CLF’s chromite deal was probably a bad one; perhaps management will end up deciding not to develop the project.

Feedback welcome.