Cliffs Natural Resources (
) has been able to leverage its position as the largest producer of
iron ore pellets in North America to forge long-standing
relationships with some of the largest steel manufacturers in the
world. Cliffs' biggest customers are ArcelorMittal (
), Algoma and Severstal - each of which individually accounts for
more than 10% of Cliffs' total revenues in the last 3 years. While
this is no doubt a strength for Cliffs, it also exposes the company
to some concentration risks should any of these companies break off
their relationships with Cliffs in the future. Cliffs competes with
other international mining and natural resources
companies like Vale (
), BHP Billiton (
) and the Rio Tinto group.
We maintain a $103 price estimate for Cliffs Natural
, roughly 8% ahead of market price.
The Benefits to Cliff's Relationships
Cliffs has multi-year supply agreements with almost all
customers of its North American iron ore business. This division is
the company's biggest source of revenue, contributing to almost
two-thirds of Cliffs total sales for the year 2010. The division's
five largest customers together have accounted for more than 80% of
the division's revenues in recent years.
Also, in most of the cases, Cliffs is also the sole supplier of
iron ore pellets to these customers. And they have significant
price advantages linked to the agreements which require them to buy
a minimum quantity of iron ore each year. This ensures the sale of
a bulk of Cliffs' produce every year.
This arrangement obviously comes at some cost to Cliffs. The
guarantee of purchase by any customer is offset by a discount of as
much as 10% in the prevalent spot-price for iron ore. This limits
the potential upside for Cliffs in case there is a significant rise
in the price of iron ore in a particular period.
Moreover, in our recent article titled,
relationship between giants - Cliffs Natural Resources &
, we highlighted how ArcelorMittal's focus on iron ore
self-sufficiency in order to reduce its steel production costs will
lead to a fall in sales between the two companies.
… And Recent Changes
The biggest concern is the building tension between Cliffs and
its two biggest customers, ArcelorMittal and Algoma. In 2010,
global iron ore producers moved away from the annual international
benchmark pricing mechanism in favor shorter-term pricing
arrangements linked to the iron ore spot market. Cliffs has these
supply agreements with ArcelorMittal and Algoma, and this change
resulted in arbitrations and litigations between Cliffs and these
companies. While the results of the individual proceedings can
result in material revenues or costs for Cliffs, it can adversely
lead to a cancellation of the supply agreements.
What this Would Mean for Cliffs' Stock
We currently estimate that Cliffs sales to ArcelorMittal will
reduce to about 8 million tons by the end of our forecast period.
However if we consider a scenario where volumes are halved from
current events like a loss of Algoma's contracts, this would mean a
fall in slightly more than 5% of its total estimated value.
See our full analysis for Cliffs Natural Resources