Why Cliffs Stock Soared 40% Tuesday

Iron ore miner Cliffs Natural Resources Inc. (NYSE: CLF) announced Tuesday morning that it has signed a 10-year agreement with the U.S. division of ArcelorMittal (NYSE: MT) to supply iron ore pellets to the steelmaker’s U.S. plants. The contract specifies a minimum annual delivery of 7 million long tons, with a top end of 10 million long tons (2,240 pounds).

In its press release, Cliffs noted that the minimum level of purchases is higher than the current minimum on the two contracts the new agreement replaces. That’s the reason Cliffs shares traded up nearly 40% in the first hour of trading Tuesday. Analysts at JPMorgan reinstated a price target of $7 per share on the stock and raised its rating from Neutral to Overweight.

When Cliffs reported first-quarter results in late April, the company said it expected to produce 16 million tons of iron ore pellets in the United States this year. Unless the company was already figuring in an increase in the amount ArcelorMittal USA was taking, that number should go up.

At the end of March, iron ore pellets were fetching around $73 per metric ton (2,204.6 pounds, or about 0.984 long tons). At the time, 62% iron ore fines were priced at around $55 a short ton (2,000 pounds), which implies a price of between $74 and $76 per ton for pellets.

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Iron ore prices shot up earlier this year after Chinese officials said that 2016’s economic growth target of 6.5% to 7.0% would be met at any cost. That lit a fire under iron ore prices.

Two weeks ago, the world’s largest iron ore producer, Brazil’s Vale S.A. (NYSE: VALE) warned that new production would drive down iron ore prices. That may have been the company talking its own book, though, as it prepares to begin operations at an expanded mine in northeastern Brazil. Vale is aiming to sell more iron ore to China, while the Cliffs deal with ArcelorMittal is all based within the United States.

JPMorgan’s $7 price target represents an implied gain of 128% to Cliffs’ closing price on Friday and 62% to Tuesday morning’s high bid of $4.33. Investors should also keep in mind that short sellers had some 37% of its float on last look.

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Another positive view from JPMorgan was significantly better earnings growth prospects in the near term. Rising steel prices should translate into higher earnings. To prove a point, hot-rolled coil prices recently traded up over $600 per metric ton, versus the company’s guidance assumptions of $450 per metric ton.

In the late morning Tuesday, Cliffs traded up more than 35%, at $4.16 in a 52-week range of $1.20 to $5.83. The consensus estimate is $2.86, and the high estimate (before JPMorgan’s boost) was $6.