Cliffs Natural Resources (CLF), the largest producer of iron ore pellets in the U.S., recorded third-quarter 2009 profits of 45 cents, significantly lower than last year’s earnings of $1.61 per share, on weak iron volumes and prices. However, reported earnings were in contrast to the Zacks Consensus Estimate of a loss of 6 cents. Consistent with weaker year-over-year global demand for iron ore — the steelmaking raw material — revenues in the quarter tumbled 44% to $666.4 million.

Performance by Segments

North American Iron Ore: Sales in the segment slipped 47% to $428.2 million on a 31% decline in volumes to 5.5 million tons. Iron ore production halved to 4.6 million tons in the quarter. Demand for iron ore pellets remained weak year over year despite steel demand picking up in the last quarter. Capacity utilization in the North American steel industry ramped from 49% in the beginning of the quarter to 59% at the end. However, the current utilization of 60% remains well below the 2008 levels.

North American Coal: Revenues in the segment plunged 63% to $37.9 million on a 62% drop in volumes to 343,000 tons. Lower sales volume was driven by weak market conditions impacting demand for steel in both US and Europe. Coal production was down 63% to 294 million tons.

Asia-Pacific Iron Ore: Sales dipped 29% to $165.3 million despite a 23% increase in volumes. Average prices for iron ore shipments declined 42% to $62.71 per ton from $108.23 per ton in the year-ago period. Cliffs is currently selling to customers in China under provisional pricing arrangements that are consistent with the 2009 iron ore settlements for iron ore lumps and fines reached between producers and other Asia-based consumers outside of China.

Third-quarter 2009 production of 2.1 million tons in Asia-Pacific Iron Ore was a 53% increase year over year, driven by higher production at Koolyanobbing mine in Australia. We expect production to improve further with production start-up at the Cockatoo Island Joint Venture in 2010 upon completion of a seawall project at the mine.

At the end of the quarter, Cliffs had $359.9 million of cash and cash equivalents, compared with $179.0 million at Dec. 31, 2008. With a debt of $525 million, the company has maintained its debt to capitalization ratio at a comfortable 20%. This should help Cliffs to raise funds for acquisition, if required.

Outlook

Cliffs expects to sell about 17.4 million tons of iron ore in 2009, foreseeing a sequential increase in demand. Recently, certain steelmakers in Europe agreed to a price settlement decrease of about 48% for iron ore pellets. As a result, the company expects average revenue per ton in the North American Iron Ore business segment to be about $75 to $80 in 2009. Currently, the North American Iron Ore business segment is expected to produce 15 million tons in 2009 at a cost of $65 to $70 per ton.

Cliffs has narrowed its sales guidance to 1.8 million tons of coal from 2 million tons at average revenues of $95 to $100 per ton. A reduction in expected production is decreasing leverage over fixed costs, which is expected to result in average cost of sales of $135 to $140 per ton, down from the initial expectation of $150 to $160 per ton in 2009.

Asia-Pacific Iron Ore 2009 sales volume is expected to be 8.5 million tons, an increase from previous expectations of 8.0 million tons. Anticipated production of 8.1 million ton is slightly above the previous expectation of 8.0 million tons. Cliffs expects Asia-Pacific Iron Ore to achieve 2009 revenue per ton of $60 to $65, with costs per ton of $50 to $55 per ton.

Cliffs has a 45% economic interest in Sonoma Coal and expects total production of 2.9 million tons for 2009. Sonoma is expected to have a sales volume of 3.1 million tons. Declining demand for high cost metallurgical grade coal has forced Cliffs to cut production. The company expects sales mix between thermal and metallurgical grade coal to be about 70% and 30%, respectively, compared with the previous guidance of 60% and 40%. As a result, in 2009 revenue per ton is expected to be $100 to $105, with per-ton cost at Sonoma from $85 to $90, higher than the previous estimate of $75 to $85.

We are optimistic about Cliffs’ focus on growing its international exposure after facing a consistent decline in North American production. The recent Wabush mine acquisition — which owns and operates iron ore mining and pellet facilities in Newfoundland, Labrador and Quebec in Canada — is consistent with this approach, as the production will be sold primarily in Europe. We reiterate our Neutral recommendation on the stock.
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