Cliffs Natural Earnings Fail to Live Up to Investors' Hopes

Image: Cliffs Natural.

The commodity industry has been out of favor for years now, and iron-ore company Cliffs Natural Resources has been one of the hardest-hit stocks in the market. Coming into Wednesday morning's second-quarter financial report, investors in Cliffs Natural had bid up the company's stock by more than 25% in a single day, hoping that the hard-hit company would finally be able to turn things around, and get back on track for a long-term recovery.

Yet instead of reporting a smaller loss than investors had expected, Cliffs Natural fell short of the consensus forecast on both the top and bottom lines. Although the stock held up well the day of the announcement, it dropped back toward its previous levels throughout the remainder of the week. Let's take a closer look at Cliffs Natural's latest results and look at why shareholders got whipsawed during the past week.

Earnings fall off Cliffs Cliffs Natural's second-quarter results reflected the severity of the downturn that the iron-ore producer has seen recently. Revenue plunged by a third, to $498 million, falling short of what investors had expected to see by nearly $100 million. Although Cliffs Natural's GAAP earnings were far better than forecast, at $0.39 per share, income from discontinued operations of more than $100 million was solely responsible for allowing the company to earn a profit. Looking just at adjusted income from continuing operations, Cliffs lost $32.4 million, and that corresponded to an adjusted loss of $0.21 per share, far worse than the $0.11 loss that was the consensus forecast.

Signs of the company's struggles were visible throughout Cliffs Natural's various segments. In the U.S. iron ore division, sales volumes eased down 2%, to 4.24 million long tons, while production volume fell a steeper 5%, to 5.5 million long tons. Sales margins plunged, falling by roughly two-thirds on an aggregate basis, and cash-cost declines of about $5 per ton weren't nearly enough to offset the nearly $30 per ton decline in revenues compared to the year-earlier quarter. Asia-Pacific iron ore showed similar results, with sales margins falling by three-quarters despite a slight increase in production volume, and a reduction in cash costs of $15 per ton.

CEO Lourenco Goncalves tried to keep investors focused on the immediate goal, noting that. "we have taken actions to protect the long-term viability of Cliffs." Pointing to strategic moves to shed its eastern Canadian iron ore exposure, and with the sale of other non-core assets, Goncalves remained confident in Cliffs Natural's ability to survive the downturn.

How can Cliffs Natural recover?Yet at least for now, Cliffs Natural remains on the defensive. The company cut its full-year sales and production volume expectations for the U.S. iron ore market by 1.5 million tons, with its new 19 million ton estimate reflecting low capacity utilization rates among its steel-producing customers. Imported steel has helped push overall demand from U.S. producers down, and while Cliffs expects some improvement in the second half of the year, it nevertheless thinks basing its projections on current trends is appropriate. Elsewhere, Cliffs maintained its guidance for the Asia-Pacific segment, expecting 11 million tons of volume with cash production costs of about $30 to $35 per ton.

It's unclear why it took a couple of days for the reality of Cliffs Natural's tepid results to take hold with shareholders, although the confusion about what seemed to be an earnings beat before taking discontinued operations into account could have prompted the initial celebration, and delayed reaction to the downside. In the long run, though, Cliffs has a long way to go in order to execute on its strategy of using its geographical proximity to key steel-producing customers in the U.S. Midwest, and working with them to bolster new, innovative production processes that require direct-reduced-ready iron-ore pellets. In the meantime, if poor conditions persist in the global iron-ore market, Cliffs will continue to struggle for survival.

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