Cleveland Cliffs Inc (CLF)

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ML Downgrade:

We downgrade CLF to Neutral from Buy as we contemplate a more cautious
outlook on iron ore. While much of potential excess supply and more modest
demand seem priced into shares, we see limited upside amid likely further iron
ore pressure. We are confident in CLF’s ability to lower costs and add capacity
but a weaker iron ore price trumps these accomplishments in our view. Sustained
cash flow strength and a 5% dividend yield rest on a certain iron ore price, which
may be at risk. Our new estimates use the forward curve at $120/t for 2013E iron
ore vs a prior $140/t. We assume Chinese and global steel demand growth ~5%.
Supply/demand imbalance risks
New third-party capacity is starting to ramp up, even as demand expectations
have become more muted. While we may be early with our iron ore price
concerns, we consider higher-cost miner CLF vulnerable to added capacity.
Fortescue is targeting an additional 100M tons of capacity within the next 12
months, and even if we assume shortfalls, a range of 25-75M new tons supplies
much of global steel demand growth and contributes to excess supply into 2013.
Capex discipline detailed by Rio and BHP does not seem to apply to iron ore.
Earnings power deteriorates at $120/mt iron ore
Benchmark iron ore prices have fallen ~10% since peaking above $150/mt in mid-
April. We estimate CLF can earn $2.4B of EBITDA and $6.20/shr in 2013 using
$120/t for iron ore, which we consider a near-term floor equating to Chinese
marginal costs. We are comfortable with CLF’s dividend at prices above $120/t.
Lower price objective to $60, Neutral rating
We cut our PO to $60 from $84 as execution timing and iron ore prices did not
play out as we’d expected. Our new price objective blends 5.5x 2012-14E
EV/EBITDA, vs a historical through-the-cycle forward 6x EV/EBITDA since 2005.
Despite the cautious price and multiple we still arrive at a Neutral rating for CLF.