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Summary

  • Outlook for the metals and minerals industry looks soft due to volatility in prices.
  • Cliff Natural Resources has been experiencing several challenges.
  • It wise to stay away from Cliffs Natural Resources.

Cliffs Natural Resources (NYSE:CLF) has had been going through a difficult time. The company has already lost 46% of share price in 6.5 months due to rumors, predictions, and their tumbling financial situation. Recently, Morgan Stanley has predicted that the iron ore price will fall in the coming days, which will have a strong impact on its financial performance and liquidity situation. Stanley says that with a seaborne surplus, iron ore price will reach $105 per ton this year and $90 per ton next year. This forecast will impact iron companies like Cliffs Natural Resources, Vale SA (NYSE:VALE), BHP Billiton (NYSE:BHP), and Rio Tinto (NYSE:RIO), but it is predicted that lower iron prices will damage Cliffs Natural Resources the most. Additionally, Stanley also said that Cliffs could infringe its credit facility's max Funded Debt to EBITDA agreement. Stanley estimate Funded Debt to EBITDA will raise to 4x in 2014 against the allowable maximum of 3.5x.

Furthermore, Deutsche Bank has cut its earnings per share estimate to $0.50 (-46% vs prior) for this year. In addition, iron ore prices are expected to fall more in 2015, so earnings per share estimate will fall to $0.24 (-63%) in 2015 and $0.26 (-84%) in 2016. The falling iron ore prices will also impact its dividends. Deutsche Bank predicted that Cliffs could stop paying dividends from the start of the next year in order to preserve cash. Furthermore, Cliffs Natural Resources is also experiencing problems in its management and board of directors as Casablanca now wants to take majority of Cliff's eleven-person board. Casablanca also wants to make changes in the company's business model to reduce losses. In Casablanca's recent letter to share holders, they explained the reason behind the changes:

Since we began our campaign to create value for all of Cliffs's shareholders late last year, we have consistently emphasized that the company is substantially undervalued as a result of strategic missteps, blatant mismanagement, and a misalignment of incentives between Cliffs's shareholders and its board of directors and management…

A majority of the current board and nine-member slate of directors up for reelection approved both the $4.9 billion Consolidated Thompson transaction to acquire the Bloom Lake project and the subsequent $1.5 billion in capital expenditures. These ill-conceived investments were part of a broader diversification strategy that included the Coal, Chromite, Wabush, and Amapá projects for a total outlay of $9 billion. None of these projects currently contributes one cent to earnings…

Cliffs Natural Resources has responded to Casablanca Capital:

The company's board and new management team led by Gary Halverson have taken - and will continue to take - decisive steps to reduce costs and prudently allocate capital while steadily improving Cliffs's financial and operating performance, including through the ongoing, comprehensive review of our portfolio of assets and strategic options. This board and management team is best positioned to deal with the difficult price environment Cliffs is dealing with today. Change is already underway at Cliffs, and we remain committed to enhancing value for all of our shareholders. Based on discussions with various shareholders, the board of directors is nominating a slate of nine directors for its eleven-person board. As a result, we believe that at least two of Casablanca's proposed nominees will be elected to the Cliffs board, so shareholders should vote using the Company's WHITE proxy card.

I hope that both Cliffs and Casablanca agree on the company's executives issue and growth strategy. The question remains: what should Cliff's investors do, and is it a good time to jump in Cliffs when its share price is significantly down? I will briefly try to answer those questions.

Cliffs Natural Resource has been struggling since it moved towards the acquisition of the Bloom Lake Project along with other big investments and the volatility in the commodity prices in addition to the fall of profits. Its earnings per share fell from $11.48 per share in 2011 to $2.37 in 2013, and the company has suffered a big loss of ($6.32) per share in 2012. Its free cash flows turned negative and its dividend payments are higher than its free cash flows. Thus, in the start of 2013, it had to slash its quarterly dividend to $0.15 per share from $0.62 per share. Cliffs has also made a change in its business strategy as it is now looking to lower its capital investments in order to enhance its liquidity position. In the past year, it has reduced capital investments and is further looking to reduce its investments by 55% in 2014. It is only looking to expand production from existing assets while lowering the cost of production and rightsizing its organization.

The company has recently announced its first quarter results, which shows that the company is experiencing very strong headwinds. Due to the iron ore and metallurgical coal prices, the company's revenue decreased by 18% and sales margin by massive 73%. Thus, earnings per share came out to a negative $0.54 per share. Its operating and free cash flows also turned negative and are even not providing cover to capital expenditures. Moreover, based on Stanley's and Deutsche Bank's predictions, its losses will expand in the coming days with the fall in iron prices, which is its front line product.

In Conclusion

Having the philosophy of a defensive investor, I do not think it is wise to jump into Cliffs Natural Resources on the significant fall in the share price. The company has been facing a number of problems, including the constant fall in the price of its main product line and differences between top position holders for the executive position and other members. Aside from all this, I think the forecasted price of iron ore presented by two big banks and a risk of ceasing dividends advises investors to stay away from Cliffs.

Source: Is It Wise To Stay Away From Cliffs Natural Resources?