Seeking Alpha
Long only, value, special situations, contrarian
Profile| Send Message| ()  

Like most relationships, the affair between Cliffs and Canada started off with a long slow flirtation, then got hot and heavy, cooled off, and eventually got downright dysfunctional. On a Valentine's Day press conference, Cliffs Natural Resources (CLF) told Canada "It's not you, it's me."

How it Began: Cliffs Courting of Canada

Cliffs began their flirtatious foray into Canada with a small investment in the Canadian iron ore mine called Wabush, which sits in the Southern portion of the Labrador Trough and lies in close proximity to ArcelorMittal's (MT) Quebec Cartier mine also known as Mont Wright, and the Iron Ore Company of Canada's Carol Lake mine. Cliffs made another minor overture to Canada in 1997 when they paid Inland $15 million in order to increase their interest in the Wabush mine from 7.8% to 22.8%.

After 1997 Cliffs' ardor for Canada cooled till the heady days of 2009 when Cliffs began a series of investments that the company thought would allow them to one day rival the likes of other mining behemoths like Brazil's Vale (VALE) and Australia's BHP Billiton (BHP).

The romance with Canada blossomed after a series of legal battles with other mining companies who had an interest in the Wabush mine. The discussions with the other minority owners was contentious to say the least. However, Cliffs eventually secured a 100% ownership of the Wabush mine, holding off other suitors like US Steel (X), ArcelorMittal, and Consolidated Thompson. Following their Wabush victory, Cliffs went on a spending binge in Canada pursuing not only other iron ore properties, but ferroalloy mines as well.

The courting continued with the purchase of First Point Minerals Corp. (OTC:FPOCF) in 2009, which gave Cliffs a 51% controlling interest in a nickel-iron alloy property called Decar. Cliffs then went on to purchase Freewest Resources in January of 2010, which gave Cliffs control of an exciting chromite exploration property called Black Thor, which sits in Northern Ontario's Ring of Fire. The purchase of Freewest also gave Cliffs a 47% interest in another chromite explorer called Spider Resources. Cliffs continued its affair with Canada by eventually taking 100% ownership of Spider Resources in June of 2010, which gave Cliffs control of the Black Label and Big Daddy chromite properties that are also situated in the Ring of Fire. You can read more about Cliffs' acquisition of its chromite mines here.

Cliffs final and most grand gesture to Canada was its multi-billion dollar offer to purchase the nascent iron ore producer Consolidated Thompson in May of 2011, which gave Cliffs a 70% controlling interest in the Bloom Lake mine. Additionally, the acquisition gave Cliffs several other smaller iron ore properties that provided a potential pipeline of iron ore development assets for the decades to come.

By mid 2011, Cliffs had big dreams for its relationship with Canada. The dream at Bloom Lake was to ramp up its phase I production to 8 million tonnes "MT" per year, and use the profits from phase I to build out phase II, which would allow Bloom Lake to produce a total of 16 MTs of high grade iron ore concentrate per year. Additionally, Cliffs dreamed that its newly acquired chromite and nickel-iron exploration plays would allow Cliffs to become a major global player in the ferroalloy business in just a few short years after some development work was completed.

In an April 2011 conference call, then CEO Joseph Carrabba stated how Consolidated Thompson, and de facto the other Canadian properties, played into Cliffs overall strategy:

As I have said before, this acquisition[Consolidated Thompson] is a low-risk opportunity to accomplish a number of strategic objectives, including building scale by enhancing our global portfolio of assets, diversifying our customer base with increasing exposure to seaborne markets, establishing relationships with new customers in Asia and expanding our global presence.

Source

(click to enlarge)

Location of Cliffs Canadian Mineral Properties: Source Cliffs Natural Resources 2013 10-K, published 2/14/14

Where it Started to Go Wrong

Shortly after the purchase of Consolidated Thompson, Cliffs' stock price was near its all time highs of over $100 a share in the Spring and Summer of 2011. However, Cliffs investments in Canada started to sour soon thereafter. Initial per tonne operating costs were projected in the Consolidated Thompson feasibility study to be in the $30-$50 range when Cliffs first purchased the mine from Consolidated Thompson. Unfortunately, Cliffs management almost immediately found issues with tailings management at the mine site, as well as higher labor and logistics costs than were originally anticipated. Additionally, Cliffs found issues with pre-stripping and stripping ratios at the mine, and as if that wasn't enough Cliffs also had issues with processing the Bloom Lake ore at the concentrate facility.

In a 2011 Q3 conference call--only a few months after the largest acquisition in Cliffs' history--Mr. Carrabba expressed to analysts his initial concerns with operating-expense "op-ex" inflation. Mr. Carrabba stated the following in response to a question by analyst Arun S. Viswanathan:

Arun S. Viswanathan- Susquehanna Financial Group, LLLP, Research Division

I guess, could you guys give us a little bit more detail on what you see on the cost side on Eastern Canadian Iron Ore and in the U.S. It seems like costs have been trending a little bit higher. What would you expect for both Bloom Lake and Wabush over the next several quarters? Where do you think we can get on a steady-state on cost, cash costs?

Joseph Carrabba Chairman, Chief Executive Officer and President

Well, I think, just, if you will, just to repeat myself on Eastern Canada on the Bloom Lake, I think I gave that explanation pretty thoroughly that we still thought we'd be in the $60 range as we get there, but we're shaking the mine down and we've taken, again as things have been a little bit slower, deliberately taking some actions to improve the process going into '12.

Source: Seeking Alpha Transcripts

Additionally, in a Q1 2012 conference call Mr. Carrabba said the following regarding their cash cost per tonne of $98 at Bloom Lake:

Candidly, we recognize cash cost at Bloom Lake are higher than expected. While this is not ideal, we have a plan in place to optimally run and expand this operation. Within this plan, we will continue to adjust the Phase 1 flow sheet until we are satisfied with the products consistency and production reliability. In the shorter term, these adjustments could impact cost, as they did in the first quarter. Despite this, I believe our Phase 1 cash cost start up at $60 per ton is still realistic and achievable. Better yet, we will apply the knowledge we gain from Phase 1 to our Phase 2 ramp up.

Source: Seeking Alpha Transcripts

Unfortunately, for Cliffs, cash costs at Bloom Lake have never come down and due to inflated exploration and development costs Cliffs has yet to develop its phase II operation at Bloom Lake or develop its pipeline projects at Lamelee or Peppler Lake. In Cliffs' Valentine's Day conference call, Cliffs told analysts that cash costs per tonne at Bloom Lake were still hovering around $90 per tonne range.

Shortly after acquiring 100% of the Wabush mine, Cliffs went on to spend millions of dollars upgrading the mine's ability to process ore with high levels of manganese. Despite the company's best efforts to reduce costs and create a competitive concentrated hematite pellet from the Wabush mine, the company wound up with a cash cost per tonne of around $143 this last quarter.

At Cliffs' ferroalloy properties Cliffs spent huge sums of money developing these exploration properties in British Columbia and Ontario. Expenses were focused mainly on drilling, conducting scoping and feasibility studies, as well as on environmental assessments. Unfortunately, for Cliffs it met huge amounts of resistance from first nations indigenous communities, local government, and most notably a resistance to Cliffs infrastructure development plans.

Fallout From Cliffs Operational Setbacks in Canada

In late November of 2013, Cliffs made its first hint that it was slowly withdrawing from its relationship with Canada. The first shot across the bow came at Cliffs' chromite properties where the company decided to indefinitely suspend the development of these mines and effectively take their losses as a sunk cost and move on. You can read more about Cliffs' chromite decision here.

The next major development came on February 11th, 2014, when Cliffs decided that it would be unable to continue operations at its Wabush mine due to the inability to reduce operating costs. Cliffs said they would indefinitely idle the mine until they could either find a buyer, or the price of iron ore rebounded significantly. In the same press release Cliffs mentioned that it would also suspend the development of Bloom Lake phase II development and would possibly idle Phase I if pricing weakened significantly in the next several months.

Furthermore, the last straw came this past Friday, Valentine's Day, when Cliffs held their 2013 Q4 conference call. In the Q&A session Cliffs outright stated that the company was not going to continue operating Bloom Lake alone, and that it was actively looking for a partner or outright sale of the mine. The following text is from Mr. Gary Halverson, the new CEO of Cliffs, responding to an inquiry from analyst Mitesh B. Thakkar:

Gary B. Halverson

Sure, Mitesh. Yes, Phase II, I think we made it pretty clear that we are not going ahead with Phase II on our own. We determined that the Phase I with reduced capital spend and focusing on operating cost performances, where we have to stay right at this point. I think the guys have further work to do in that in the short-term. But if I look at the longer-term, we're not going to be running Phase I forever either this is a transition period to look at opportunities from a strategic partnering and up to and including of sale just to give the range.

It's too early to say what that will turn into for us at this point, but we've had interest from financial partnering, from customer interest, and Kelly may add further through that. But overall, the focus here is to reduce and get better performance out of Phase I right now while we look at those strategic options.

Source: Seeking Alpha transcripts

What it All Means for Cliffs Natural and Its Shareholders

Cliffs' love affair with Canada has seemingly come to an end this past Friday with the announcement that Cliffs is planning an outright sale of its flagship Canadian mine. The indefinite idling of its Wabush plant, and the cessation of exploration and development activities at its ferrochrome properties near the Ring of Fire cement the fact that Cliffs is not likely to return to Canada as a miner anytime in the near future. Ultimately, this is a good thing for shareholders as it will allow the company to cut its huge cap-ex projects and operational losses and instead focus on its profitable operations in North America and to a lesser extent in Australia. Additionally, shareholders should rejoice at the potential for large one time gains from the outright sale of Bloom Lake or Wabush and for the potential for larger quarterly profits and dividends as Cliffs' management focuses on returning capital to shareholders.

Thank you for taking the time to read this article, I encourage readers to leave questions and comments below.

Source: Cliffs Broke Up With Canada On Valentine's Day