In my earlier article on Cliffs Natural Resources (NYSE: CLF), I discussed the possible consequences of the leadership change after the activist fund Casablanca Capital took control of Cliffs' board. Since then, two important things happened. First, Cliffs authorized a $200 million buyback on August 25. Second, Wall Street Journal reported that Cliffs hired investment banks to help it sell non-core assets. While it was not clear which exact path the company will follow when I wrote my previous article in early August, the new management's approach became clearer since then. In my view, the outlook has become more bearish for Cliffs. Here's why.
Not a good time for buyback at all
In a typical situation, a buyback is a good way to return money for shareholders when the company cannot find good ways to spend this money on growth. However, this is not the case for Cliffs. The company has many problems, and debt is one of them. Cliffs finished the second quarter with $360 million of cash on the balance sheet and $3.3 billion in debt. Yet, instead of trying to reduce the debt burden, the company announced that it wanted to spend $200 million on the buyback. For me, it makes no sense at all, as it undermines an already shaky liquidity position.
The last sentence needs additional clarification. Yes, Cliffs amended its revolving credit facility in the second quarter, which brought total liquidity at the quarter's end to $1.8 billion. However, increasing debt even more is not a good choice in the current conditions. That's why I judge Cliffs' liquidity by its cash on hand rather than by its ability to borrow more money.
What's more, the buyback announcement came at times when iron ore prices hit new lows. This is the situation when a company needs more resources, not less. Low iron ore prices will put further pressure on Cliffs' operating cash flow, which has already been negative for two quarters in a row. The authorization of the buyback makes Casablanca Capital's strategy very clear. The activist fund wants to cash out of its position and the buyback must support shares on the market.
The sale of Australian assets is a wrong move
According to a Wall Street Journal report, Cliffs wants to sell its coal assets, as well as its Australian assets. The decision to get rid of the coal business is viable, as coal has been a source of constant cash bleed for Cliffs. Returning to the buyback theme, it is highly unlikely that Cliffs is going to finance it from cash on hand. Thus, the company possibly plans to finance the buyback from asset sales - a strategy that is detrimental for long-term shareholder value.
The decision to sell Australian assets is worrisome. While iron ore prices test new lows, the price that Cliffs could get for its Australian operations will be low. With cash cost of $53.38 per ton in the second quarter, Australian operations are not a drag, despite the fact that Australian iron ore prices are low. The rationale to hurry with the sale of Australian assets is dubious at best. However, this move highlights the new management strategy. Instead of dealing with the biggest problem, which is the Bloom Lake mine, Casablanca Capital is focused on asset sales, hoping that those sales will bring upside for Cliffs' shares.
I'm bearish on Cliffs because I believe that the management's strategy is wrong. Instead of dealing with the main problems, which are the debt burden and the company's Canadian operations, the management is focused on hurried asset sales. In my view, this will undermine Cliff's long-term position. Thus, I expect more pressure on Cliffs' shares.
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