Amidst seasonally slow quarter, Cliffs Natural Resources Inc. (CLF) posted record revenues and earnings in the first quarter of 2011. Net earnings of $423 million or $3.11 per share in the first quarter were 449%, above last year’s $77 million or 57 cents. Earnings surpassed the Zacks Consensus Estimate of $2.25 per share.

Quarterly revenues came in at $1.2 billion, up 63% year over year. The increase was driven by several factors, including higher pricing in each of Cliffs’ business segments and the favorable effect of Cliffs’ previously disclosed negotiated settlement with ArcelorMittal USA Inc.

Operating income in the quarter increased 377% year over year to $541 million.

Segment Performance

North American Iron Ore: Due to shipping constraints on the Great Lakes, Cliffs’ North American Iron Ore business is seasonally slower in the first quarter compared with other periods. First-quarter 2011 North American Iron Ore pellet sales volume was 3.5 million tons, down 19% year over year.

In first-quarter 2011, North American Iron Ore revenues per ton were $168.31, up 77% year over year. Cost per ton was $56.63, down 19% year over year, primarily due to the negotiated settlement with ArcelorMittal. The settlement resulted in Cliffs reducing cost of goods sold by $54 million during the first quarter.

In total, the negotiated settlement with ArcelorMittal had a $194 million favorable impact on Cliffs’ North American Iron Ore sales margin during the first quarter of 2011. The balance of the settlement will be recognized later in the year as the remaining tons are shipped.

In addition, as part of the settlement, Cliffs and ArcelorMittal have agreed to replace the previous pricing mechanism with a quarterly world market-based pricing mechanism beginning in 2011 and through the remainder of the contract for one of the iron ore supply agreements that Cliffs has with ArcelorMittal. As a result of the new pricing feature, going forward, both parties also agreed to forgo future price reopeners.

North American Coal: Revenues nearly doubled to 1.3 million tons from the 662,000 tons sold in the prior-year quarter, driven by 621,000 tons of incremental sales volume from the West Virginia coal operations of INR Energy, which Cliffs acquired in mid-2010. Partially offsetting the increase was a scheduled longwall machine move during the first quarter of 2011 that resulted in production downtime and slightly lower sales volumes from Cliffs’ Pinnacle Mine in West Virginia compared with the year-ago quarter.

Revenue per ton increased 19% year over year to $123.83. Cost per ton increased 5% year over year to $126.14, driven by the longwall machine move. Cliffs indicated this resulted in approximately $3 per ton of additional costs during the first quarter of 2011. Moreover, in anticipation of the planned ramp-up in production volume, headcount increased at Cliffs’ Pinnacle and Oak Grove mines, which contributed to the higher quarter-over-quarter costs.

Asia-Pacific Iron Ore: Asia Pacific Iron Ore sales volume was virtually flat at 2.2 million tons compared with 2.1 million tons in the first quarter of 2010. Revenue per ton in Asia-Pacific Iron Ore increased 67% year over year to $155.52 on higher prices in the seaborne market. Per ton cost of goods sold increased 20% to $67.36 in the first quarter.

Financial Position

To finance a portion of its pending acquisition of Consolidated Thompson, Cliffs entered into a $1.25 billion term loan and a bridge credit facility that currently provides up to $960 million in bridge financing during the quarter. Due to the pending close of the Consolidated Thompson acquisition, Cliffs did not borrow either of these agreements during the first quarter of 2011. As a result, there were no amounts outstanding from either agreement as of March 31, 2011.

Moreover, during the quarter, Cliffs priced two tranches of 10-year and 30-year public senior notes totaling $1 billion in aggregate principal amount. The $700 million, 10-year tranche closed prior to quarter end and is reflected on the balance sheet as of March 31, 2011, with the $300 million 30-year tranche closing subsequent to the end of the first quarter. Cliffs intends to use the net proceeds from both tranches to finance a portion of its pending acquisition of Consolidated Thompson.

At the end of March 31, 2011, Cliffs had $2.3 billion of cash and cash equivalents, $2.4 billion in long-term debt and no borrowings were drawn on its $600 million revolving credit facility.

For the quarter, Cliffs reported depreciation, depletion and amortization of $79.8 million and generated $107 million in cash from operations.

Consolidated Thompson Update

During the quarter, Cliffs announced its intention to acquire Consolidated Thompson, an emerging world-class iron ore producer located in Eastern Canada. This pending transaction reflects Cliffs’ strategy to build scale by owning expandable and exportable steelmaking raw material assets serving the world’s emerging economies. While adding Consolidated Thompson’s operations and development projects to Cliffs’ global portfolio of assets, the acquisition will also provide Cliffs the opportunity to build and grow strong business relationships with Consolidated Thompson’s current customers. These new customers will enable Cliffs to continue to strategically diversify the company’s customer base beyond its historical North American steelmaking customers.

SonomaCoal and the Amapa Iron Ore Project

In the first quarter of 2011, Cliffs’ share of sales volume for its 45% economic interest in Sonoma Coal was 252,000 tons. Revenues and sales margin generated $35.3 million and $11 million, respectively. Revenue per ton at Sonoma was $140.10, with costs of $96.47 per ton.

Cliffs has a 30% ownership interest in the Amapa Iron Ore Project. During the quarter, Amapa produced a total of 1.1 million tons and earned equity income of $2.6 million.

For 2011, the Company is decreasing Sonoma Coal’s equity sales and production volumes expectation to 1.2 million tons from the prior expectation of 1.6 million tons, driven by the exceptionally wet weather. The approximate product mix is expected to be two third of thermal coal and one third of metallurgical coal. Cliffs expects per-ton costs to be $110 – $115, up from its previous expectation of $105 – $110.  Cliffs expects Amapa to be modestly profitable in 2011.


Cliffs anticipates global steel production to continue to grow in 2011, primarily driven by emerging economies such as China, India and Brazil.

During the first quarter, Cliffs announced it had entered into a definitive arrangement agreement with Consolidated Thompson Iron Mines Limited. This transaction is expected to close in early second quarter of 2011, subject to the satisfaction or waiver of various closing conditions. After closing this transaction, Cliffs anticipates to include this business in subsequent market outlooks.

SG&A expenses are anticipated to be approximately $200 million in 2011. The company anticipates an effective tax rate of approximately 27% for the year and depreciation, depletion and amortization of approximately $360 million.

Cliffs expects to generate more than $2.6 billion in cash from operations in 2011. The company expects capital expenditures of approximately $700 million, comprising approximately $300 million in sustaining capital and approximately $400 million in growth and expansion, including the following projects within Cliffs’ business segments:

North American Iron Ore Outlook

For 2011, the Company increased its sales volume expectations to approximately 29 million tons from a previous expectation of 28 million tons.

The Company maintained its North American Iron Ore revenue-per-ton expectation of $140 – $145 based on the following assumptions, 2011 U.S. blast furnace utilization of approximately 75%; 2011 average hot rolled steel pricing of $700 – $750; and an average increase of 35% over 2010’s pricing for seaborne iron ore.

Cliffs expects its North American Iron Ore 2011 production volume to be approximately 27 million tons and cost per ton of $65 – $70, with approximately $5 per ton comprising depreciation, depletion and amortization.

North American Coal Outlook

Earlier Cliffs expected 2011 North American Coal sales and production volumes of approximately 6.5 million tons, including 1 million tons of thermal coal, 1.5 million tons of high-volatile metallurgical coal and 4 million tons of low-volatile metallurgical coal.

With the natural disaster at Oak Grove and the difficulty in immediately assessing impact, the Company is not providing updated sales volume, production volume, revenue per ton or cost per ton outlook at this time. Cliffs will continue with its assessment and further information will be communicated as appropriate and available.

Asia Pacific Iron Ore Outlook

Asia Pacific Iron Ore 2011 sales and production volumes are expected to be 9 million tons. Cliffs’ 2011 Asia Pacific Iron Ore revenue-per-ton expectation is $165 – $170. Costs per ton are expected to be approximately $70 – $75. The year-over-year increase in the average cost expectation is primarily driven by higher royalties, higher stripping costs and a less favorable foreign exchange rate. Depreciation, depletion and amortization costs per ton are expected to be $12.

Cliffs faces stiff competition from CONSOL Energy Inc. (CNX), Massey Energy Co. (MEE) and Peabody Energy Corp. (BTU).

We maintain our Neutral recommendation on Cliff with a short-term Zacks #3 Rank (Hold) on the stock.

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