Cliffs Natural Resources Inc.

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1 March 13, 2015 Cliffs Natural Resources Inc. Current Recommendation NEUTRAL Prior Recommendation Outperform Date of Last Change 03/25/2014 Current Price (03/12/15) $5.13 Target Price $5.50 SUMMARY DATA (CLF-NYSE) SUMMARY We are reaffirming our Neutral recommendation on Cliffs Natural Resources. The company swung to a loss in the fourth quarter of 2014 on hefty asset impairment charges, mostly related to its Eastern Canadian Iron Ore division. Adjusted earnings, however, topped the Zacks Consensus Estimate. Revenues fell by double-digits year over year, but beat expectations. Cliffs has a significant presence in the Asia-Pacific region, where demand is still robust and lending support to shipments. Management is also focused on improving the cost structure, which will bear fruit in future reporting periods. The company also remains committed to reduce debt. However, Cliffs North American Coal segment still remains under pressure due to weak pricing for coal products. Seaborne iron ore prices are also expected to remain weak in the near future. 52-Week High $ Week Low $5.13 One-Year Return (%) Beta 2.12 Average Daily Volume (sh) 5,736,822 Shares Outstanding (mil) 153 Market Capitalization ($mil) $797 Short Interest Ratio (days) 6.00 Institutional Ownership (%) 74 Insider Ownership (%) 1 Annual Cash Dividend $0.60 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 6.6 Earnings Per Share (%) Dividend (%) 3.3 P/E using TTM EPS 3.0 P/E using 2015 Estimate 51.3 P/E using 2016 Estimate 11.2 Zacks Rank *: Short Term 1 3 months outlook 2 - Buy * Definition / Disclosure on last page Risk Level * 2015 Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL High, Type of Stock N/A Industry Mining -Iron Zacks Industry Rank * 115 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,141 A 1,489 A 1,547 A 1,516 A 5,691 A A 1,101 A 1,298 A 1,285 A 4,624 A E 789 E 925 E 1,097 E 3,442 E ,163 E *Note: Quarterly figures in 2013 do not add up to the annual figure due to onetime adjustments. Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.60 A $1.13 A $0.65 A $1.22 A $3.84 A $0.68 A -$0.01 A $0.21 A $1.00 A $1.73 A $0.15 E $0.02 E $0.14 E $0.09 E $0.10 E 2016 $0.46 E *Note: Quarterly figures in 2013 and 2014 do not add up to the annual figure due to one-time adjustments. Projected EPS Growth - Next 5 Years % 5

2 OVERVIEW Cleveland, Ohio-based Cliffs Natural Resources Inc. (CLF) is the largest producer of iron ore pellets in North America, besides being a major supplier of metallurgical coal in North America. Cliffs U.S. based mines has a rated capacity of 32.9 million gross tons of iron ore pellet production annually, representing about 56% of the total U.S. pellet production capacity. Based on the percentage of ownership in the mines operated, the company s share of the rated pellet production capacity is currently 25.5 million gross tons annually, representing about 44% of the total U.S. annual pellet capacity. The current reportable segments of Cliffs are U.S. Iron Ore, North American Coal and Asia-Pacific Iron Ore. The U.S. Iron Ore segment comprises Cliffs ownership in 3 mines in Minnesota (Hibbing Taconite, Northshore and United Taconite mines) and 2 in Michigan (Empire and Tilden mines). The company produced 29.7 million tons of iron ore pellets at U.S. Iron Ore in Cliffs is a leading supplier of metallurgical and thermal coal. Its North American Coal unit consists of 2 coal mines, situated in West Virginia and Alabama. The company sold 7.4 million tons of coal in The Asia-Pacific Iron Ore division is represented by Cliffs fully-owned Koolyanobbing complex in Western Australia. The segment registered total production of 11.4 million metric tons in REASONS TO BUY Cliffs sees continued economic growth in the U.S. to support domestic steel production and demand for steelmaking raw materials in Steel demand in the U.S. is expected to be backed by strength in the automotive sector and a recovering housing market. Moreover, increasing steel production in China is expected to lead to higher demand for the company s products in the country. Cliffs is boosting its mining and transportation capacity globally. It has also employed a global exploration program, which is aimed at identifying and capturing new world-class projects. Cliffs will also benefit from its pellet supply contracts with its U.S. iron ore customers which will help it to mitigate the impact of fluctuation in seaborne iron ore pricing. Cliffs has implemented a strategic capital allocation plan to ensure the optimum utilization of cash. Its focus remains on providing maximum return to the shareholders by way of dividend distribution and share buybacks while maintaining its organic growth pipeline. In line with this strategy, the company s board has authorized it to repurchase shares worth up to $200 million. Cliffs is also focusing on cost management amid a weak pricing environment, reflected by reduction in its selling, general and administrative (SG&A) expenses in The company expects further reduction in SG&A costs of around $70 million to $140 million in Cliffs remains focused on deleveraging its balance sheet. The company repaid net debt worth $300 million during the most recent quarter and ended 2014 with total debt of roughly $3 billion. Cliffs further cut its net debt by $100 million in January 2015, using the net proceeds from the sale of its Logan County coal assets and cash from operations. This will reduce the company s interest expenses. Equity Research CLF Page 2

3 The decision to exit the Eastern Canadian Iron Ore business represents another positive for Cliffs. The company suspended production at its Bloom Lake project in December 2014 and ceased operations at the mine in January The Bloom Lake mine stopped generating any revenues and was unable to meet its obligations. Moreover, the company idled and closed its Wabush Scully Mine due to its high cost structure. Closure of Wabush Scully and stoppage of operations at Bloom Lake marked the complete exit of the company s Eastern Canadian Iron Ore operation. Cliffs also no longer has any financial liabilities associated with the Bloom Lake operation. The move has allowed the company to shift into a pure-play U.S. iron ore supplier. REASONS TO SELL Excess capacity is still weighing on commodity prices. Cliffs has been significantly challenged by declining iron ore pricing. Seaborne iron ore spot prices fell 45% in fourth-quarter 2014, hurting the company s realized revenue rate. Prices are expected to remain under pressure, partly due to increased supply. Cliffs North American Coal segment also remains under pressure due to soft pricing for metallurgical coal, impacted by increased supply from Australian producers. International demand and economic conditions strongly affect the prices of iron ore and coal. The current uncertain macroeconomic environment, including slowdown in Europe, may impact the company s operations and its results. Moreover, demand for raw materials used in steel production is mostly driven by rapid industrial growth in China. If China witnesses decelerating economic growth rate for an extended period of time, demand Cliffs product will decrease, thereby impacting its sales and margins. The company s decision to indefinitely suspend the chromite mining project in Ontario represents a setback. Cliffs has decided to discontinue all developmental activities indefinitely at the chromite project. The project s uncertain timeline and risks associated with the development of infrastructure led the company to decide against investing any additional capital. Cliffs has a high customer concentration. Its largest customer ArcelorMittal accounted for 22% of its consolidated product revenues and 40% of U.S. Iron Ore product revenues in This has a negative influence on product pricing and exposes the company to customer-concentration risk. RECENT NEWS Cliffs Natural Posts Loss in Q4, Beats Estimates February 2, 2015 Cliffs reported fourth-quarter 2014 net loss of $1.3 billion, or $8.25 per share as against net income of $30.5 million or $0.20 per share in the year-ago quarter. The bottom line was hit by asset impairment charges, a major part of which are related to the Eastern Canadian Iron Ore unit due to the earlier announced exit of these operations. Excluding impairment charges and other items totaling $1.4 billion, adjusted earnings came in at $1.00 per share, outpacing the Zacks Consensus Estimate of $0.15. Equity Research CLF Page 3

4 For full-year 2014, Cliffs reported net loss of $7.2 billion, or $47.29 per diluted share compared with net income of $364.8 million or $2.39 per share in This include Eastern Canadian Iron Ore operating margins, charges related to certain asset and goodwill impairments and other items totaling $7.5 billion. Excluding these items Cliffs reported full-year adjusted earnings of $259 million, or $1.73 per diluted share, ahead of the Zacks Consensus Estimate of $0.14. Sales for the quarter came in at $1,284.7 million, down 15.2% from $1,515.8 million in the prior-year quarter. Sales, however, exceeded the Zacks Consensus Estimate of $1,251 million. The decline was due to lower revenues from the Asia Pacific Iron Ore and Eastern Canadian Iron Ore segments For the full year, sales were $4,623.7 million, down 18.8% from It beat the Zacks Consensus Estimate of $4,577 million. Segment Performance U.S. Iron Ore: U.S. Iron Ore pellet sales volume was 7.8 million tons in the fourth quarter, compared with 6.2 million tons in the year-ago quarter. The increase was mainly driven by higher customer demand in the Great Lakes and also continued catch-up from the delayed start of the shipping season in the spring of Revenues per ton were down 12.2% year over year to $98.93 and cash cost per ton decreased 5% year over year to $59.06 in the reported quarter. Asia Pacific Iron Ore: Sales volumes in the segment declined 2% to 2.9 million tons due to port maintenance timing. Revenues per ton were $54.96, down 49.6% from $ in the prior-year quarter. Cash cost per ton in the segment fell 25% to $ North American Coal: Sales volumes increased 9% to 1.9 million tons, driven by increased thermal sales from Cliffs Logan County Coal, which was excluded from the portfolio during the quarter due to the sale, and higher sales from Pinnacle. Revenues per ton decreased 16.9% to $ Cash cost per ton was at $57.28, down 30% year over year. Eastern Canadian Iron Ore: Sales volumes in the reported quarter declined 37% year over year to 1.4 million tons, reflecting reduced shipments from Wabush Mine, which was idled in first-quarter Revenues per ton for the segment decreased 40.1% year over year to $ During the fourth quarter of 2014, production was ceased at this operation. Financial Position Cliffs had $290.9 million in cash and cash equivalents as of Dec 31, 2014, compared with $335.5 million as of Dec 31, Long-term debt stood at $2,962.3 million as of Dec 31, 2014, compared with $3,022.6 million as of Dec 31, Capital expenditure reduced 57% year over year to $51 million in the fourth quarter primarily due to the cease of Eastern Canadian operations. Depreciation, depletion and amortization amounted to $74 million. Equity Research CLF Page 4

5 Mine Restructuring In Jan 2015, Cliffs stated that Bloom Lake General Partner Limited and certain of its affiliates, including Cliffs Quebec Iron Mining ULC (collectively called Bloom Lake Group) have started restructuring proceedings in Montreal, Quebec, under the Companies' Creditors Arrangement Act (Canada) ("CCAA"). The Bloom Lake group had previously suspended operations and has been looking for opportunities to sell some of its Canadian assets. The Bloom Lake Group has stopped generating any revenues and is unable to meet its obligations. The Initial CCAA Order will deal with the Bloom Lake Group's immediate liquidity issues and will allow it to preserve and protect its assets for the advantage of all stakeholders while restructuring and sale options are being explored. Outlook Starting in 2015, Cliffs is providing full-year expected revenues-per-ton ranges based on different assumptions of seaborne iron ore prices to offer more financial transparency to its shareholders. The company has trimmed its SG&A expenses on a year over year basis which are expected to be about $140 million. The decrease is mainly due to a reduction in headcount and reduced outside services spending resulting from a smaller global footprint. Cliffs' expects full-year cash outflow for exploration spending to be less than $5 million. Consolidated full-year 2015 depreciation, depletion and amortization is expected to be roughly $150 million. The company forecasts its full-year 2015 capital expenditures budget in the range of $125-$150 million. U.S. Iron Ore Outlook For 2015, Cliffs anticipates full-year sales and production volume of about 22 million tons from its U.S. Iron Ore business. Cliffs does not intend to export any pellets out of the Great Lakes in Iron Ore cash production cost is expected to be in the range of $55-$60 per ton in Asia Pacific Iron Ore Outlook For 2015, Cliffs expects sales and production volume to be about 11 million tons. The product mix is expected to be roughly 51% lump and 49% fines iron ore. This is based on the assumption that no divestiture of this business will take place in 2015, which may or may not occur. Asia Pacific Iron Ore cash production cost per ton is expected to be around $40-$45 in Cash cost of goods sold per ton has been forecast in the range of $40-$45 reflecting operational improvements and a more favorable foreign exchange rate compared to North American Coal Outlook For 2015, Cliffs expects sales and production volumes to be around 5.5 million tons of low-vol metallurgical coal from the two remaining mines Pinnacle and Oak Grove. This is based on the assumption that no additional divestiture of this business will take place in 2015, which may or may not occur. Equity Research CLF Page 5

6 North American Coal cash production cost has been forecast in the band of $65-$70 per ton. The company's cash cost of goods sold per ton expectation is $70-$75. Cliffs Natural Posts Loss in Q3 on Hefty Charges October 27, 2014 Cliffs reported third-quarter 2014 net loss of $5.9 billion, or $38.49 per share compared with a net income of $104 million or $0.66 per share in the year-ago quarter. The bottom line was hit by impairment charges of around $5.7 billion associated with its coal and iron ore assets. Excluding the impairment charge and other items, adjusted net income came in at $0.21 per share, outpacing the Zacks Consensus Estimate of $0.05. Sales for the quarter came in at $1,298.2 million, down 16.1% from $1,546.6 million in the prior-year quarter. Sales, however, exceeded the Zacks Consensus Estimate of $1,277 million. The decline was due to significantly lower market pricing for iron ore and metallurgical coal. Segment Performance U.S. Iron Ore: U.S. Iron Ore pellet sales volume was 6.8 million tons in the third quarter, compared with 6.3 million tons in the year-ago quarter. The increase was mainly driven by a single customer with an additional contract in 2014 and higher shipments to customers that had been impacted by the freeze on the Great Lakes in first-quarter Revenues per ton were down 10.6% year over year to $100.7 and Cash cost per ton increased 0.1% year over year to $64.87 in the reported quarter. Eastern Canadian Iron Ore: Sales volumes in the reported quarter declined 12% year over year to 2.3 million tons, reflecting reduced shipments from Wabush Mine, which was idled in first-quarter Revenues per ton for the segment decreased 33.5% year over year to $ Cash cost per ton dropped 12.4% to $ Asia Pacific Iron Ore: Sales volumes in the segment rose 11% to 3.1 million tons due to rail and vessel timing. Revenues per ton were $69.04, down 36.6% from $ in the prior-year quarter. Cash cost per ton in the segment fell 11.9% to $ North American Coal: Sales volumes increased 15% to 1.9 million tons, driven by increased low-volatile export sales and additional spot sales, increased thermal sales associated with a new contract and higher high-volatile sales resulting from new export relationships. Revenues per ton decreased 23.5% to $ Cash cost per ton was at $72.49 down 4.8% year over year. Financial Position Cliffs had $244 million in cash and cash equivalents as of Sep 30, 2014, compared with $298.8 million as of Sep 30, Long-term debt stood at $3,012.5 million as of Sep 30, 2014, compared with $3,319.6 million as of Sep 30, Capital expenditure reduced 71% year over year to $69 million in the third quarter and depreciation, depletion and amortization amounted to $144 million. Equity Research CLF Page 6

7 In Oct 2014, Cliffs amended its revolving credit facility with its syndicate of banking partners. The amendment also reduces the size of the existing unsecured facility from $1.250 billion to $1.125 billion and includes a security agreement. Outlook For the rest of 2014, demand for Cliffs' steelmaking raw materials and domestic steel production is expected to be backed by continued improvement in construction activity, energy extraction and motor vehicle production. The company expects economic growth in the U.S. to continue through the rest of For 2014, the guidance for SG&A expenses has been lowered to $165 million from about $185 million, which excludes severance, change in control and proxy-contest-related costs. Cliffs also narrowed its fullyear cash outflows expectation to $10 million from $15 million expected previously. Cliffs expects its full-year depreciation, depletion and amortization to be roughly $485 million, while capital expenditures budget is anticipated to be at the bottom end of the previously projected guidance range of $275 million to $325 million. U.S. Iron Ore Outlook For 2014, Cliffs reiterated its sales and production volume at 22 million tons. Iron Ore pellet cash-cost expectation is maintained in the range of $65 $70 per ton. Depreciation, depletion and amortization for the full year are expected to be roughly $5 per ton. For 2015, the company hopes to sell about 22 million tons of pellets from its U.S. Iron Ore business. Cliffs also decided to discontinue exporting pellets through the St. Lawrence Seaway in Eastern Canadian Iron Ore Outlook For 2014, sales and production volume for Bloom Lake mine is expected to be 6.5 million tons. The sales volume expectation does not include roughly 1 million tons from Wabush Mine. Cliffs maintained its full-year 2014 cash-cost-per-ton forecast for the segment in the range of $80 $85. Depreciation, depletion and amortization for full-year 2014 are expected to be roughly $19 per ton. Asia Pacific Iron Ore Outlook For 2014, Cliffs reaffirmed its sales and production volumes expectations of around 11 million tons. The product mix is expected to contain 53% lump. The company trimmed its cash cost per ton guidance to $50 $55 from its previous expectation of $55 $60. Depreciation, depletion and amortization is anticipated to be about $13 per ton for the year. In 2015, Cliffs expects to sell roughly 11 million tons including 52% lump. North American Coal Outlook For 2014, Cliffs expects sales and production volumes to be around 7 million tons. Cliffs reaffirmed its expectations for revenues-per-ton of $75 $80 and its full-year cash-cost-per-ton expectation of $85 $90. Depreciation, depletion and amortization is expected to be about $14 per ton for In 2015, Cliffs expects to sell about 8 million tons from the assignment. Equity Research CLF Page 7

8 VALUATION Cliffs current trailing 12-month earnings multiple is 3X, compared to the 5.8X average for the peer group and 18X for the S&P 500. Over the last five years, the company s shares have traded in a range of 3.8X to 39X trailing 12-month earnings. The stock is trading at a premium to the peer group based on our earnings estimate for 2015 and Our Neutral recommendation on the stock indicates that it will perform in line with the broader market. Our price target of $5.50 is based on 55x our 2015 EPS estimate. Key Indicators P/E F1 P/E F2 Est. 5-Yr EPS Gr% P/CF P/E P/E 5-Yr High P/E 5-Yr Low Cliffs Natural Resources Inc. (CLF) Industry Average S&P Vale S.A. (VALE) African Minerals Limite (AMLZF) MMX Mineracao e Metalicos S.A. (MMXMY) Mesabi Trust (MSB) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Cliffs Natural Resources Inc. (CLF) Industry Average S&P Equity Research CLF Page 8

9 Earnings Surprise and Estimate Revision History Equity Research CLF Page 9

10 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CLF. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1129 companies covered: Outperform %, Neutral %, Underperform 8.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research CLF Page 10