By and large, it's good to have industry-low cash production costs in a commodity industry, but even high-cost producers can do well when prices shoot up. That's exactly what investors in Cliffs Natural Resources (NYSE:CLF) need to hope for in 2013, as this high-cost North American iron ore producer just doesn't look very compelling absent a big improvement in margins per ton.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

A Tough Close to the Year
Cliffs Natural Resources didn't end the year on a particularly strong note. Revenue fell 8% from the year-ago quarter and about 1% from the third quarter, largely due to lower prices for iron ore. Pricing and volumes were mixed across the company's segments. U.S. iron ore (USIO) volumes dropped 20% and pricing fell about 7%, while Canadian (ECIO) volumes increased 20% (but were about one-third those of USIO) and pricing fell 19%. In the Asia Pacific operations (APIO), volume shot up 56% but pricing dropped almost one-quarter, while North American coal operations saw a big increase in volume (up 94%) and pricing fell about 12%.

While revenue performance wasn't bad, the company saw gross profit decline about 50% on stubbornly higher costs. Even so, cash production costs weren't so horrible - falling 3% in USIO, falling 5% in APIO and less than 1% in the coal ops, while ECIO costs shot up 14% and were almost 16% higher than the per-ton sales price. Overall, EBITDA fell 58% from last year and came in almost one-quarter lower than analysts had expected.

SEE: A Clear Look At EBITDA

The Cost Problem Just Isn't Going Away
I don't want to harp on Cliffs' high production cost, but I think it's a key detail for prospective investors to understand. Iron ore prices are what they are. Cliffs gets a modest premium for the high quality of its Canadian iron ore, but it also has to accept a somewhat convoluted formula for its U.S.-produced iron ore (which largely is restricted by cost from the seaborne market).

Overall, Cliffs' costs run more than $60 per metric ton (with the costs in the Canadian operations much higher this quarter). While that's not terrible relative to a global average that is also in the $60s, it is not at all competitive with the world's largest producers - Rio Tinto (NYSE:RIO), Vale (NYSE:VALE) and BHP Billiton (NYSE:BHP) - whose costs run in the range of the low $30s to mid $40s per ton.

That cost disadvantage makes it considerably harder for Cliffs to do well when iron ore prices are weaker, and it makes the company highly dependent on higher prices. Unfortunately, with a lot of new iron ore capacity coming on-line this year, the prospects for a big upswing in iron ore prices are looking worse.

Shoring up the Balance Sheet
Management isn't sitting around waiting for things to get worse. The company announced a sizable dividend cut (from 62.5 cents per share per quarter to 15 cents), and also announced that it would be raising equity capital through two offerings that could bring in close to $900 million in new capital. Obviously, this capital raise will be dilutive to shareholders, but the company needs capital if it's going to continue expanding its operations.

Speaking of the expansion plans, it looks like the plans to double production from Bloom Lake are on hold until 2014. Given the costs of expansion and the generally mediocre outlook for ore prices, that may not be such a bad move.

SEE: Evaluating A Company's Management

The Bottom Line
It's hard for me to be positive on Cliffs Natural Resources. In particular, I believe the company has structural cost issues that just won't get substantially better. For instance, I think the company would normally consider shutting the high-cost ($166/ton) Wabush mine in Canada. However, doing so could create complications with permitting to expand Bloom Lake, so the company likely just has to swallow the higher costs at Wabush to reap the potential benefits from the high-quality Bloom Lake mine.

That said, nobody really knows where iron ore prices will go in 2013. If prices shoot up again, Cliffs Natural Resources will definitely benefit. I'm not terribly interested in commodity producers that are so highly leveraged to price, though, and I think these shares are quite expensive relative to Vale, BHP Billiton or Rio Tinto.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Investing

    Have Commodities Bottomed?

    Commodity prices have been heading lower for more than four years, being the worst performing asset class of 2015 with more losses in cyclical commodities.
  4. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  5. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  6. Investing

    Oil: Why Not to Put Faith in Forecasts

    West Texas Intermediate oil futures have recently made pronounced movements. What do they bode for the world market?
  7. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  8. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  9. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  10. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!