january 16 th 2015 team zinc a financial and strategic analysis of cliffs natural resources

January 16th 2015

Team Zinc

A Financial and Strategic Analysis of Cliffs Natural Resources

Introduction

1- Description of The Company

2- Macro Factors Affecting Cliffs

3- Industry Analysis

4- Analysis of Strategic Initiatives

5- Valuation

About Cliffs

Iron Ore and Metallurgical Coal

• US Iron Ore• Easter Canadian Iron Ore• Asia Pacific Iron Ore• North American Coal• Other

Business Segments

EBITDA Contribution

Ore 92%

Coal 8%

Iron Ore MinesMetallurgical Coal MinesChromite Mines

50% of sales linked to benchmark price. 62% CFR in China

85% of sales Of USIO are to these

5 customers• Essar Steel• Algoma• AK Steel• Severstal• Arcelor Mittal

Macro Factors Affecting Ore Industry

Construction in China

• Construction more expensive when interest rates rise Less demand for steel

CAPEX• Mining industry requires billions in CAPEX for growth.• Projects take many years Increased interest rate risk• Harder time finding lenders as interest rates rise

Asset Backed Borrowing

• A lot of steel is purchased through credit, with steel backing the loan.• As interest rates rise and the price of steel falls, financiers flood the market

with steel in order to reclaim their loans Lowers steel price

Macroeconomic environment is extremely unfavorable

Metals Price Drivers

Oversupply• Large competitors are increasing production creating oversupply• Steel production is low in China (8bn tones less from March- November 2014)• Inventories have been growing for 6 months (April- September 2014)

Weak Financing in

China

• Weak demand for financing in China (New Yuan loans were $702bn, down 10bn)

• Aggregate financing in China was 957bn, estimates were 1135bn

• Building sales fell 7 straight months to November 2014 and housing prices down for the 4th consecutive month

Futures• New York Mercantile Exchange (Future contracts on Iron ore are trading below spot

prices)

Steel production is key driver for ore prices Downward pressure on ore prices

Macro Factors Affecting Ore Industry

Industry Analysis

Life Cycle MatureRevenue Volatility HighCapital Intensive HighIndustry Assistance LowConcentration HighRegulation HighTechnology Change LowBarriers to Entry HighGlobalization MediumCompetition High

Classification Industry Details

• China represents major portion of Demand Key indicator

• Long Lead times, Heavy investment, Risk

• Companies are price takers Must lower cost to be profitable

• US price more stable, linked to long term contracts and IODEX

• Seaborne sales are tied to IODEX price Lower prices

• Keeping cost of production low is crucial to success• Focusing on US contracts is more profitable and less risky

Threats

• China is moving away from infrastructure development and more towards consumer goods

• demand for steel• China shutting down steel

manufacturers to cut pollution• Tighter credit in China Less steel

demand

Supply Threat Demand Threat

• Competitors have much lower cost/tonne $20

• They have plans to grow and increase output

Metallurgical Coal

Iron ore

• China Imposed 3% tariff October 2014• China imports 1Q2013 3.9M tones 1Q2014 0.78M tones• Current price ($100-$130/tone) Cliff’s Cost ~$100 per tone• When considering SG&A, Margin per tone ~-$25 (Mines run at a loss)

Key Ratios OpportunityReturn on Assets

12 monthsJun-30-2009





12 monthsJun-30-2014 Average

BHP Billiton 14.2% 14.2% 21.1% 13.2% 9.6% 9.0% 13.6%Vale 4.6% 13.0% 15.0% 6.9% 8.7% 7.0% 9.2%Rio Tinto 4.8% 11.3% 12.1% 4.9% 7.1% 7.8% 8.0%Cliffs 3.2% 12.8% 13.5% 3.3% 4.8% 2.7% 6.7%

Quick Ratio12 months

Jun-30-200912 months





Jun-30-2014 AverageBHP Billiton 1.4x 1.5x 0.9x 0.6x 0.6x 0.9x 0.98Vale 1.6x 1.1x 1.3x 1.2x 1.4x 1.3x 1.31Rio Tinto 1.0x 1.1x 1.1x 0.9x 1.0x 1.2x 1.03Clif fs 1.1x 1.9x 0.5x 0.4x 0.6x 0.4x 0.80

Debt Maturity Schedule

2014 2015 2016 2017 2018 2019+ $-

$500

$1,000

$1,500

$2,000

$2,500

• Credit Downgraded to BBB-• Cliffs Return on assets is below its 6 year average and trailing competitors• Quick ratio of 0.4X is alarming difficulty covering debt

Maturity schedule provides flexibility if Cliffs can sell some underperforming assets

Current Strategic Initiative

Retrenchment

Macro environment is pushing Iron Ore prices low

Divest Canadian mines because of high production costs

Re-focus on American segment

Bloom Lake & Wabush

Bloom Lake Situation

• Operations ceased• $4.9 Billion investment in

2011• Operated last year at a

loss of approximately $23.38/ton (cost 94$/ton)

Phase II Potential

• $1.2 billion infrastructure investment required

• Currently no equity partners to speak of (Investissement Quebec talks too early to speculate)

• At current IODEX prices, extremely unfeasible

Wabush Situation

• Operations ceased since February 2014

• Production costs at $137/ton (twice US average mines cost)

Sale Potential

• Talks off with MFC Industrial• Incredibly high production costs make

sale potential almost nil in the short term

Divesting both assets is the best possible

course of action.

Ring of Fire

Investment

• $500 million investment into land facility

• Approximately $60 billion in probable reserves

• Massive concentration of Chromite

• Strong correlation with steel demand

Political Issues

• Inability to reach agreement with Ontario government and First Nations’

• Without infrastructure, asset is worthless

Looking to Sell

• No buyers at the moment

• $254 million write down of asset

• Zero cost to holding asset

Good decision to write down. Hold onto asset unless a substantial offer is made. No cost besides opportunity cost (not many opportunities at the moment)

Other Initiatives

$174 million to Coronado Coal

• Cash deal• $80-100 million savings in tax benefits• No more thermal coal exposure• Accounted for just under 25% of total

coal production

Excellent move to save cash and improve flexibility

$200 million Buyback

Shows management is confident of turn around with new

strategic initiatives

Sale of Logan County Coal Share Repurchase Plan

• Open until December 2015• Negotiated deal to use revolving credit

for this purpose

Risks & Strategic Recommendations

Sale of Underperforming Assets

• Eastern Canada operations are extremely expensive and would require significant investment from any interested party to make it worthwhile

• Selling these assets will prove difficult, although as of January 15th 2015 there are multiple interested parties in taking over the buy according to Investissement Quebec

Share Buyback

• To finance the buyback, management renegotiated revolving credit arrangement.

• This results in $500 million less in credit• Could prove to be a situation of short term

gain for long term loss due to less flexibility for future initiatives

Mitigation

• File for bankruptcy with Bloom Lake mine• Cost would be just under $100 million for

bankruptcy. • Company would save upwards of $450

million by avoiding rail take or pay contract

Mitigation

• Do not initiate buyback until some of the underperforming assets are sold to ensure cash flow is kept as high as possible

• Consider selling coal exposure due to little or no profitability

Discount Rate BuildupBeta

Beta 1.80

Market Beta 1.00

Adjusted Beta 1.53

WACC

Risk-free Rate 3.0%

Market Risk Premium 6.0%

Distressed Company Premium 6.0%

CAPM Cost of Equity 18.2%

Cost of Debt 4.1%Effective Tax Rate 10.0%After-tax Cost of Debt 3.7%

WACC 10.9%

Terminal GR 2.0%

Target Capital StrucutreDebt 50.0%

Equity 50.0%

Debt

Effective FaceTranche Rate Value

Senior Notes - Tranche 1 4.89% 700.00





Revolver Credit Line 1.87% 1,600.00

Weighted Average Effective Rate 4.08%

Valuation Methodology

Realized Revenue per Ton Forecast

USIO 547 US Asia CoalECIO 171 2015 104$ 68$ 78$ APIO 11 2016 110$ 80$ 85$ Coal 41 2017 115$ 95$ 95$

2018 120$ 110$ 100$ Base Cash Cost per Ton: 2019 125$ 125$ 105$ USIO 68$ 2020 128$ 128$ 107$ ECIO 83$ 2021 130$ 130$ 109$ APIO 53$ 2022 133$ 133$ 111$ NAC 83$ 2023 135$ 135$ 114$

2024 138$ 138$ 116$ Long Term Drivers 2025 141$ 141$ 118$ Long term inflation 2.0% 2026 144$ 144$ 121$ Cash costs inflation 2.0% 2027 146$ 146$ 123$ Discount Rate: 11.0% 2028 149$ 149$ 125$

2029 152$ 152$ 128$ 2030 155$ 155$ 131$ 2031 159$ 159$ 133$ 2032 162$ 162$ 136$ 2033 165$ 165$ 139$ 2034 168$ 168$ 141$

Valuation Assumptions

Reserves as of 12/31/2013 in MT• Estimation of saleable reserves attributable to Cliffs Natural Resources.

• Cash costs per ton increasing at 2% going forward.

• Realized prices to rebound by 2019 and grow by 2% going forward.

Key Notes

Forecasted Cash FlowsUSIO APIO Coal Revenue ($ in Millions) Cash Flows ($ in Millions)

Beginning Annual Realized Beginning Annual Realized Beginning Annual RealizedReserves Production Price Reserves Production Price Reserves Production Price Total Total Pre-Tax Cash After-Tax

LT LT MT MT ST ST USIO APIO Coal Revenue USIO APIO Coal Costs Cash Flows Tax Rate Cash Flows2014 547 22.0 41 11.0 - 41 7.0 - -2015 525 21.6 104.00 30 10.8 68.00 34 6.3 78.00 2,242 322 535 3,100 1,477 574 574 2,626 474 12.7% 413 2016 503 21.1 110.00 19 10.6 80.00 28 5.7 85.00 2,324 202 571 3,098 1,469 571 571 2,612 486 12.7% 424 2017 482 20.7 115.00 9 8.6 95.00 22 5.1 95.00 2,381 73 626 3,080 1,462 470 568 2,500 581 12.7% 507 2018 462 20.3 120.00 - - 110.00 17 4.6 100.00 2,435 - 646 3,081 1,454 - 565 2,019 1,062 12.7% 927 2019 441 19.9 125.00 - - 125.00 12 4.1 105.00 2,486 - 664 3,150 1,446 - 562 2,008 1,142 12.7% 997 2020 421 19.5 127.50 - - 127.50 8 3.7 107.10 2,485 - 101 2,586 1,438 - 85 1,524 1,062 12.7% 927 2021 402 19.1 130.05 - - 130.05 4 3.3 109.24 2,484 - - 2,484 1,431 - - 1,431 1,053 12.7% 919 2022 383 18.7 132.65 - - 132.65 1 1.0 111.43 2,483 - - 2,483 1,423 - - 1,423 1,060 12.7% 925 2023 364 18.3 135.30 - - 135.30 - - 113.66 2,482 - - 2,482 1,416 - - 1,416 1,066 12.7% 931 2024 346 18.0 138.01 - - 138.01 - - 115.93 2,481 - - 2,481 1,408 - - 1,408 1,073 12.7% 936 2025 328 17.6 140.77 - - 140.77 - - 118.25 2,480 - - 2,480 1,401 - - 1,401 1,079 12.7% 942 2026 310 17.3 143.59 - - 143.59 - - 120.61 2,479 - - 2,479 1,393 - - 1,393 1,086 12.7% 948 2027 293 16.9 146.46 - - 146.46 - - 123.02 2,478 - - 2,478 1,386 - - 1,386 1,092 12.7% 953 2028 276 16.6 149.39 - - 149.39 - - 125.48 2,477 - - 2,477 1,379 - - 1,379 1,098 12.7% 959 2029 259 16.2 152.37 - - 152.37 - - 127.99 2,476 - - 2,476 1,371 - - 1,371 1,105 12.7% 964 2030 243 15.9 155.42 - - 155.42 - - 130.55 2,475 - - 2,475 1,364 - - 1,364 1,111 12.7% 970 2031 227 15.6 158.53 - - 158.53 - - 133.17 2,474 - - 2,474 1,357 - - 1,357 1,117 12.7% 975 2032 212 15.3 161.70 - - 161.70 - - 135.83 2,473 - - 2,473 1,350 - - 1,350 1,123 12.7% 981 2033 196 15.0 164.93 - - 164.93 - - 138.55 2,472 - - 2,472 1,342 - - 1,342 1,130 12.7% 986 2034 181 14.7 168.23 - - 168.23 - - 141.32 2,471 - - 2,471 1,335 - - 1,335 1,136 12.7% 991

20,133 17,576

Costs ($ in Millions)

Significant long term value in the company, mainly from US operations

NAV Model

Value ($M) $/Share

Undiscounted Cash Flows 17,576 113.5 Present Value 6,319 40.8

Other Assets Capacity Ownership $/ton TotalLake Bloom 6.5 83% 5 33 0.2 Wabush 5.6 100% 5 28 0.2

Total Other Assets 61

Net Asset Value (Enterprise Value) 6,379 41.2 Net Debt 3,607 23.3 Implied Equity Value 2,772.83 17.9 Diluted Shares Outstanding 154.8 1.0 Value/ Share 17.91$

% premium / (discount) over market share price 105.4%

Cliffs Natural Resources Net Asset Value

• Lake Bloom and Wabush sale

price very conservative at 5$ per ton of capacity compared to

precedent transactions of 20$ per ton of capacity.

• Net Debt factors in asset retirement obligations, pension liabilities and preferred shares.

• Valuation at $17.91 provides

105.4% of upside to current

stock price of $8.72

Key Notes

Sensitivity Analysis

#REF! 9.5% 10.0% 10.5% 11.0% 11.5% 12.0% 12.5% #REF! 30% 20% 10% - -10% -20% -30%

30% 59.3 56.2 53.4 50.7 48.1 45.7 43.4 30% 25.7 34.0 42.4 50.7 59.0 67.3 75.6

20% 47.2 44.6 42.1 39.8 37.6 35.5 33.5 20% 14.8 23.2 31.5 39.8 48.1 56.4 64.7

10% 35.1 32.9 30.9 28.9 27.1 25.3 23.6 10% 4.0 12.3 20.6 28.9 37.2 45.5 53.9

- 23.1 21.3 19.6 18.0 16.5 15.1 13.8 - -6.9 1.4 9.7 18.0 26.3 34.6 43.0

-10% 11.0 9.6 8.3 7.1 6.0 4.9 3.9 -10% -17.8 -9.5 -1.2 7.1 15.4 23.8 32.1

-20% -1.1 -2.0 -2.9 -3.8 -4.6 -5.3 -6.0 -20% -28.7 -20.4 -12.1 -3.8 4.6 12.9 21.2

-30% -13.1 -13.7 -14.2 -14.6 -15.1 -15.5 -15.9 -30% -39.6 -31.3 -23.0 -14.6 -6.3 2.0 10.3

#REF! 9.5% 10.0% 10.5% 11.0% 11.5% 12.0% 12.5% #REF! 9.5% 10.0% 10.5% 11.0% 11.5% 12.0% 12.5%

30% -4.1 -5.1 -6.1 -6.9 -7.8 -8.5 -9.3 2.75% 26.4 24.4 22.6 20.8 19.1 17.6 16.1

20% 4.9 3.7 2.5 1.4 0.3 -0.7 -1.6 2.50% 25.3 23.4 21.6 19.9 18.2 16.7 15.3

10% 14.0 12.5 11.1 9.7 8.4 7.2 6.1 2.25% 24.2 22.3 20.6 18.9 17.4 15.9 14.5

- 23.1 21.3 19.6 18.0 16.5 15.1 13.8 2.00% 23.1 21.3 19.6 18.0 16.5 15.1 13.8

-10% 32.1 30.1 28.2 26.3 24.6 23.0 21.4 1.75% 22.0 20.3 18.7 17.1 15.7 14.3 13.0

-20% 41.2 38.9 36.7 34.6 32.7 30.9 29.1 1.50% 20.9 19.3 17.7 16.2 14.9 13.5 12.3

-30% 50.2 47.7 45.3 43.0 40.8 38.7 36.8 1.25% 19.9 18.3 16.8 15.4 14.0 12.8 11.6

Discount Rate vs Long Term Cash Costs

Discount Rate

Cash

cos

ts

Long Term Cash Costs vs Long Term Commodity Prices

Cash Costs

Com

mod

ity

Pric

es

Discount Rate vs Commodity Price Inflation

Discount Rate

Com

mod

ity

Pric

e In

flati

on

Discount Rate vs Long Term Commodity Prices

Discount Rate

Com

mod

ity

Pric

es

Comparables ValuationEV / EV /

Revenue EBITDA P/E

Valuation Comps

Small Cap Iron Ore Producer Median Multiple 1.2x 6.7x 6.9x

Clif fs Natural Resources Metrics 4,870 1,007 133

Enterprise Value 6,039 6,747Net Debt (3,607) (3,607)Equity Value 2,432 3,140 918

Diluted Shares Outstanding 155 155 155

Fair Price per Share 15.71$ 20.28$ 5.93$ Closing Share Price (Jan 15th) 8.72$ 8.72$ 8.72$

% Upside (Downside) 80% 133% (32%)

Comp SheetP/E EV/EBITDA EV/Revenue Price/FCF

security_name TTM Current Next TTM Current Next TTM Current Next TTM Current Next Company Name Year Year Year Year Year Year Year Yearsecurity_name pe_ratio BEST_PE_RATIO ev_to_t12m_ebitdaEST_EV_THIS_YR_EBITDAEST_EV_NEXT_YR_EBITDAev_to_t12m_salesEST_EV_THIS_YR_SALESEST_EV_NEXT_YR_SALESPX_TO_FREE_CASH_FLOWBEST_PX_CPS_RATIOBEST_PX_CPS_RATIOSmall Cap Iron Ore ProducersMount Gibson Iron Ltd 2.8x N/A N/A 2.0x 10.1x 10.2x 0.8x 0.7x 0.8x 1.4x N/A 40.8xAtlas Iron Ltd N/A N/A N/A N/A 3.3x 3.8x 0.6x N/A 0.2x N/A 7.8x 3.7xAlderon Iron Ore Corp N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/AKumba Iron Ore Ltd 5.2x 6.9x 10.5x 4.1x 3.6x 4.7x 2.1x 1.7x 1.8x 5.2x 5.1x 7.4x

Median 2.8x 6.9x 10.5x 2.0x 6.7x 7.0x 0.7x 1.2x 0.5x 1.4x 7.8x 22.3xMean 2.8x 6.9x 10.5x 2.0x 6.7x 7.0x 0.7x 1.2x 0.5x 1.4x 7.8x 22.3x

Large Cap Iron Ore ProducersFortescue Metals Group Ltd 2.1x 7.0x 7.3x 3.6x 4.2x 4.3x 1.7x 1.3x 1.3x 1.7x 4.0x 2.9xBHP Billiton Ltd 8.5x 12.0x 11.6x 7.0x 5.4x 5.3x 3.2x 2.4x 2.3x 14.1x 6.0x 5.8xRio Tinto PLC 12.5x 8.9x 10.7x 6.1x 5.6x 6.1x 2.4x 2.2x 2.3x 14.5x 6.4x 6.7xVale SA N/A 8.0x 9.7x 5.1x 4.4x 5.0x 2.0x 1.7x 1.7x 22.1x 2.9x 4.4x

Median 8.5x 8.5x 10.2x 5.6x 4.9x 5.2x 2.2x 1.9x 2.0x 14.3x 5.0x 5.1xMean 7.7x 9.0x 9.8x 5.5x 4.9x 5.2x 2.3x 1.9x 1.9x 13.1x 4.8x 5.0x

Cliffs Natural Resources Inc N/A N/A N/A N/A 7.0x 9.3x 1.1x 1.1x 1.3x 6.0x 2.3x 2.3x

LiquidityTotal Debt Net Debt Debt Quick Current

Company Name Yield EBITDA EBITDA Cap Ratio RatioTOT_DEBT_TO_TRAIL_12M_EBITDANET_DEBT_TO_EBITDATOT_DEBT_TO_TOT_CAPQUICK_RATIOCUR_RATIOSmall Cap Iron Ore Producers

0% 79% 55% 46% 1% 2%Arch Coal Inc 3% -60% N/A 70% 3% 4%Ferrexpo PLC 0% 1% 0% 37% 2% 4%

Median 0% 1% 28% 46% 2% 4%Mean 1% 7% 28% 51% 2% 3%

Large Cap Iron Ore ProducersFortescue Metals Group Ltd 10% 2% 1% 56% 1% 1%BHP Billiton Ltd 5% 1% 1% 29% 1% 1%Rio Tinto PLC 5% 1% 1% 34% 1% 1%Vale SA N/A 2% 1% 31% 1% 3%

Median 5% 2% 1% 32% 1% 1%Mean 7% 2% 1% 37% 1% 2%

7% 0% N/A 32% 1% 1%

Debt

Valuation multiples are depressed due to ongoing difficulties with Eastern Canada assets

Debt metrics in line with peers

Valuation Overview

$0 $5 $10 $15 $20 $25 $30 $35

NAV

EV/Revenue

EV/EBITDA

P/E

FootBall Field

Price target of $18 per share Implying a 106% upside

Conclusion

Team Zinc believes CLF is a definite “buy”

Negative macroeconomic factors can be overcome through the strategic allocation of assets, in particular, through focusing on

the US mining operations

Retrenchment and focusing on profitable segments of the business will put Cliffs in an extremely strong position as the macroeconomic environment pulls out of the current

slump

January 16th 2015

Team Zinc

Thank YouQuestions?

january 16 th 2015 team zinc a financial and strategic analysis of cliffs natural resources

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