Cliffs Natural Resources (CLF) shares plunged nearly 21% on the week the company reported earnings. Investors who continued to hold shares on the hope that higher iron ore prices would help Cliffs shares were disappointed. Cliffs cut its dividend by 75%, and issued shares to help reduce its $4.1 billion debt. Shares closed recently at $28.85. Cliffs did not trade for extended periods below the psychological $30 level since September 7, 2009, although shares tested these levels between November 27 and December 7, 2012.
(Data Source: Yahoo Finance)
The downtrend that began in early-2011, when shares were $98, could continue. There are three reasons for further downside:
1) Dividend Cut
Cliffs cut its quarterly dividend by 76%, to $0.15 per share, down from $0.625. The company now pays a more sustainable yield of 2.08%, compared to 8.67%. With 142.5M shares outstanding, Cliffs will save $85.5 million annually. The dividend cut clearly contributed to the sell-off in shares. Income investors who held Cliffs for income may continue to hold shares. Selling shares now would trigger a substantial capital loss. New investors looking for high-yielding companies may choose not invest in this company. The latter group of investors might consider BreitBurn Energy (BBEP), whose shares yield 9.5%. BreitBurn is also focused on growing dividends every year. Its shares declined from a peak of $21.75 recently. The company took advantage of the high share price and issued 13 million shares for $19.86 per unit, raising nearly $260 million. Like Cliffs, BreitBurn could be concerned about the future health of the financial markets and is shoring up its balance sheets.
Cliffs is less attractive than Rio Tinto for income investors. Rio increased its dividend by 15% to $1.67 per share, and now yields 2.89%.
2) $1 Billion Raised Through Share Issuance
With 142.5M shares outstanding, the 9 million (up to 10.35 million if underwriters purchase additional shares) common share offering at $29 per common share will increase outstanding shares by 7.3%. This will raise up to $300 million. The 27 million convertible preferred shares will raise $675 million. If the underwriters exercise their over-allotment option in full, the preferred shares will cost up to $54.38 million annually in distributions. These preference shares could be converted automatically into between 0.7037 and 0.8621 common share in 2016.
In December, Cliffs raised $500 million by issuing senior notes that paid an annual interest rate of 3.95% and maturing in 2018.
Cliffs is not alone in improving its balance sheet. Rio Tinto is planning to divest 20 projects over three years, which is worth $20 billion. BHP Billiton (BHP) wants to sell its coal mine in Queensland State, which could be worth A$800M. Joy Global could write-down its China-related assets. The company might provide further details when it reports on February 27, 2013.
3) Declining Revenue
Cliffs reported revenue of $5.9 billion, an 11% drop. This was due to seaborne iron ore pricing declining by 23%, higher labor, mining, and maintenance costs. Excluding charges, Cliffs earned $3.45 per diluted share.
When Vale reported Q4 results, iron ore output increased by 3.1% to 85.5 metric tons. This was better than production increases reported by BHP Billiton and Rio Tinto .
There are 4 reasons Cliffs shares could soon find support in its share price.
4) Iron Ore Demand Still Strong
Cliffs believes growth is still intact in China. In 2012, imports for iron ore increased 9% to 745 million tons. In the U.S., growth is expected to be modest. In its final quarter of the year, Cliffs sold 6.2 million tons of iron ore, and 21.6 million tons for the year. In the Asia Pacific region, sales increased to 2.8 million tons in the quarter, up from 1.8 million tons from a year ago.
Cliffs estimates iron ore prices will be $150 per ton, using average prices from January year-to-date.
Vale is bullish for iron ore. The company plans to spend $7 billion to develop iron ore and bauxite mines.
5) Coal Sales Expected to be Steady
Cliffs increased sales for North American coal by 57%, or 6.5 million tons, in 2012, up from 4.2 million tons in the previous year. The company expects sales to be 7 million tons. Metallurgical coal will make up most of the sales.
By comparison, BHP Billiton increased production in met coal by 5% in its December quarter.
6) CapEx Increasing
CapEx is expected to rise to $800 million to $850 million, up from a previous forecast of $700 - $800 million. The expenditure will be used for productivity capital and investing at Bloom Lake.
7) Impairment Charges Complete
Cliffs took a non-cash impairment charge of $1 billion for the Consolidated Thompson acquisition. $415 million in impairments were taken for Wabush and Amapa. In Rio Tinto's quarter, the company reported a loss for the first time in at least 21 years. Rio Tinto took an impairment charge of $14.4 billion.
In the near-term, negative pressure could push shares of Cliffs Natural Resources lower despite negative factors already priced in. Investors should not expect any positive catalysts of higher iron ore prices and surprisingly stronger economic activity in China. If sellers push shares to the mid-$25 level, the improved balance sheet in the company, higher capital expenditure, lower operational costs, and a sustainable dividend, could help provide support.