Business Context and Reporting Period
Company: Cliffs Natural Resources Inc. (formerly Cleveland-Cliffs Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: The Company is an international mining company and the largest producer of iron ore pellets in North America. It operates iron ore mines in Michigan, Minnesota, and Eastern Canada, and coking coal mines in West Virginia and Alabama. It also holds a majority interest in Portman (Australia) and minority interests in Amapá (Brazil) and Sonoma (Australia).
Key Financial Metrics (Nine Months Ended Sept 30, 2008)
| Metric | 2008 (9 Months) | 2007 (9 Months) |
|---|---|---|
| Total Revenues | $2,692.8 million | $1,492.7 million |
| Sales Margin | $873.8 million | $298.7 million |
| Operating Income | $791.6 million | $242.7 million |
| Net Income | $461.9 million | $176.3 million |
| Diluted EPS | $4.34 | $1.69 |
| Cash from Operations | $582.2 million | $81.0 million |
| Cash & Equivalents (End of Period) | $388.3 million | $139.6 million |
| Total Debt (Senior Notes + Term Loan) | $525.0 million | $200.0 million |
| Available Borrowing Capacity | $589.7 million | $343.8 million |
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 80% year-over-year, driven by a 42% increase in revenue per ton in North American Iron Ore due to higher steel prices and new long-term supply agreements. Supplemental steel payments contributed $195.4 million to revenue in 2008 compared to $55.7 million in 2007.
- Profitability: Net income increased 162% to $461.9 million. Operating income rose significantly due to higher sales margins, partially offset by a $94.3 million unrealized loss on derivative instruments.
- Derivative Impact: A significant non-operating loss of $94.3 million was recorded due to the de-designation of Portman's cash flow hedges effective July 1, 2008. This resulted in mark-to-market adjustments being recorded in earnings rather than other comprehensive income.
- Acquisitions: The Company acquired the remaining 30% interest in United Taconite (total consideration ~$450.7 million) and increased its ownership in Portman from 80.4% to 85.2% (cost ~$110.8 million).
- Coal Segment: North American Coal reported a sales margin loss of $38.8 million for the nine months, attributed to adverse geological conditions, production delays, and force majeure declarations.
Guidance, Outlook, and Risks
Outlook and Guidance
- North American Iron Ore: Expected 2008 revenue per ton of $91 and cost per ton of $57. Sales volume expected at 25 million long tons. 2009 average realized price projected to increase 18% to $107 per ton based on contractual adjustments.
- North American Coal: 2008 production revised down to 3.6 million short tons due to geological issues. Expected revenue per ton of $93 and cost per ton of $97.
- Asia-Pacific Iron Ore: Expected 2008 revenue per tonne of $98 and cost per tonne of $58. Full-year production/sales expected at 8 million tonnes.
- Capital Expenditures: Total 2008 CapEx expected to be approximately $240 million.
Risks and Contingencies
- Merger with Alpha Natural Resources: A proposed merger (cash and stock transaction valued at ~$1.7 billion cash + 70 million shares) is pending shareholder approval. Risks include failure to obtain approval, regulatory hurdles, and potential termination fees ($100 million or $350 million).
- Market Conditions: The global financial crisis and credit crunch may adversely affect demand for steel raw materials and limit funding for expansion.
- Legal Proceedings: Significant litigation includes a claim by Dofasco regarding Wabush interests (seeking up to C$1.8 billion) and various environmental matters (Northshore air permits, Alabama dust litigation).
- Derivatives: Continued volatility in foreign exchange rates (AUD/USD) impacts the fair value of Portman's hedging portfolio.
Investor Verification Checklist
- Merger Approval: Verify the outcome of the shareholder vote on the Alpha Natural Resources merger scheduled for November 21, 2008.
- Derivative Valuation: Monitor the impact of the de-designated Portman hedges on future earnings, given the volatility in the Australian dollar.
- Coal Production: Assess the resolution of geological issues at Pinnacle and Oak Grove mines to determine if 2009 production targets of 4.6 million tons are achievable.
- Legal Exposure: Track the status of the Dofasco litigation and the Northshore air permit appeals, as these could result in material liabilities.
- Capital Allocation: Review the execution of the $290.4 million Michigan expansion project and the $90.4 million Pinnacle longwall plow system purchase.