Replies to post #5403 on The Rising Influence of Rising Affluence

[DewDiligence]

I want to take a closer look at CLF… Just wondering why the stock is so beaten down so much lately.

Fear of a “hard landing” in China that will quash the demand for such raw materials as iron ore—see #msg-75569303 and its reply chain.

My view (expressed in many posts on this board) is that a severe slowdown in China is not that likely and the risk is already baked into CLF’s share price, which trades at a forward P/E of about 5x and sports a dividend yield of 5.4%.

Outside of [CLF’s] website, any good links to look at?

I’ve posted some stuff about CLF from Barron’s (#msg-77518003, #msg-71437978) and Bloomberg (#msg-71869156), the latter dealing with CLF’s buyout vig, which is another reason for owning the stock.

CLF’s quarterly PR’s (posted on this board) and quarterly CC’s are quite detailed, so you can learn a lot about the company just from these sources. Regards, Dew

[Democritus_of_Abdera]

Bear case for CLF...

ghmm... I agree with Dew (#msg-77545299) that the major negative factor impacting CLF’s share price over the past 6 months is a fear of a “hard landing” in China..

With respect to the near term negative bias in the stock price, I for one fear that CLF will significantly reduce its projections for FY2012 in the upcoming CC next week. The important question, in my mind, is whether the expected cash from operations will cover the anticipated $1300M needed for planned CapEx and dividends.

For the record, the projections detailed in the April 26 FY2012 Q1 conference call were:

We are maintaining our expected sales volume for all of our reporting segments with the exception of Asia Pacific Iron Ore, but we are increasing our anticipated sales volume to approximately 11.4 million tons. In addition, we are maintaining our expected 2012 full year average spot price for seaborne iron ore of approximately $150 per ton delivered into China, and have narrowed our revenue per ton expectation range for all of our segments.

As I [Lauri Brlas, CFO] mentioned before, we are decreasing our full year North American Coal revenue per ton expectation to approximately $130 to $135 due to market conditions. Included within last night’s press release, you can find our expectations for all reportable segments, along with the outlook for Cliffs other reported minority interest.

We are maintaining our expected full year SG&A expense of approximately $325 million and our cash outflow expectations of $90 million related to global exploration. For our chromite project, we expect to spend approximately $75 million in 2012. We continue to make significant progress with this project, including constructive discussions with external stakeholders and government regulators. We anticipate advancing this project from the pre-feasibility stage of development, to feasibility this summer. We continue to be excited about the quality of the ... department (22:37) and the value it would generate. As we move into feasibility, we will share portions of the project economics, as well as other significant milestones achieved and expected, as we bring this project to fruition.

We expect a full year effective tax rate of approximately 5%, which includes the impact from the Australian MRRT. Excluding this and other discrete tax items, our effective tax rate would be approximately 23% for the full year.

We anticipate generating $1.7 billion in cash from operations, down slightly from our previous expectation of $1.9 billion, primarily due to our outlook adjustments in the full year business segments. Our revised expectation more than covers our anticipated CapEx of $1 billion for the year and our recently announced 123% increase to the quarterly cash dividend rate, which will result in a total 2012 payout of just over $300 million.

Greater detail concerning CLF’s projections can be found in the April 25, 2012 Form 8K: http://www.sec.gov/Archives/edgar/data/764065/000119312512184213/d340908dex991.htm

[Democritus_of_Abdera]

Regarding possible CLF projection reduction...

The main reason that I fear CLF might reduce its FY2012 projections in the upcoming CC (i.e. on July 25) is that Cliff’s original projections were based upon an average $150/ton iron ore spot price as delivered to China. Whereas, during the past quarter the Chinese spot price has been stuck in the $130-140/ton range.

Secondarily, I suspect that CLF might continue to experience unexpected costs associated with its recent acquisition binge, although I have no hard data ... just following the trend. I doubt, however, that SG&A cost increases will have a meaningful impact upon projections.

At the out start I should warn that my fears are rarely realized, ...unfortunately, the same holds true for my hopes.... And, my actions don’t reflect my fears... i.e. I’m considering purchasing more CLF at these levels. The question is, do I make the purchase before or after the July 25th CC. Hence, the reason that I am focusing upon this issue at this time.

I have found the table published in CLF’s April news release summarizing the 2012 guidance for its four business segments useful... it is found at http://www.sec.gov/Archives/edgar/data/764065/000119312512184213/d340908dex991.htm

1) The first point is that almost half of CLF’s profits are derived from US Iron Ore sales... These sales are stable and unlikely to deviate much from current projections. ... The US income does rely in some part upon Seaborne spot prices, but according to an answer in the Apr 26 CC, this reliance is minor.

2) The second point is that changes in the expectations regarding coal income is unlikely to have a meaningful impact upon the guidance, since coal profits currently represent only a small portion of the total income.

3) So, a downgrade in revenue projections would most likely come from the Eastern Canadian and Asia Pacific iron ore accounts.

Eastern Canadian Iron Ore (12M tons estimated for FY2012) was projected to produce revenue at $140-145/ton with costs of $80-85/ton. Estimating shipping costs at about $30/ton, I believe that the net income from Eastern Canadian iron ore was projected to be about $360M... This would be reduced to about $240M if the FY2012 spot price average is reduced by $10. A reduction of $120M.

Similarly, Asian Pacific net income would be reduced from about $625M to $510M (assuming shipping costs of about $15/ton, a wild guess). A reduction of $115M.

Hence, I suspect that the basis for CLF’s projections will include an incremental reduction in net income of about $200-250M from that reported by CLF in April.

Thus, I’m speculating that CLF’s report next week will include a reduction in the guidance for cash from operations from $1.7 billion to about $1.45 billion, still above the $1.3 billion needed to cover projected CapEx and dividends.

4) SG&A costs are expected to approximate $325M in FY2012... Even though I fear that costs might increase, I doubt that the increase will be enough to meaningfully move overall cash flow guidance.

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Admittedly this is a very amateurish analysis... but I don’t have access to critical raw data and I feel that a more detailed analysis on my part might sound better, but would not be any more reliable.

An important timing question (i.e. should one purchase CLF stock before or after the CC) relates to whether or not my expectation for reduced guidance is already priced into the stock. In April CLF stock was priced at about $70/share... It is now at about $45/share.

My estimate of $30/ton for freight charges to China come from the following exchange in the Q&A of the April 26th CC:

Nathan Littlewood – Credit Suisse (Australia) Ltd
Good morning, guys. And thank you for the call. I’ve got a few questions. I’ve got a few questions about Bloom Lake. And also, a clarification on the MRRT. So first thing on Bloom Lake, the pricing of, what was it 116, I suspect that’s a lot lower than what most people on this call were looking for. If we start with a Platts price of about 144 I think you said and then you take off say $30 a ton freight, you’d get an FOB price for index funds of about 115, 116. There should then be a premium for the grade and there should be another premium for the pellets at Wabash. So I just wonder if you could give us a bit more color on why it was so low.

Joseph Carrabba – Cliffs Natural Resources, Inc.
As we talked about what with the grade, those premiums are shrinking as the market has tightened up with that. And the other thing that I explained earlier on the call, was as we put these trial cargoes in, obviously there’s some negotiation to get the first trial cargoes in as well. So you would anticipate that at any time you’re trying to get an entry point going in from there. We’ve also seen the pellets premiums shrink as well, around the world. And particularly those pellets that might be going into Asia, which are always the first that are cut off when the market tightens. But our sales folks have been able to continue to supply those as they come through the Wabush pipeline.