When I read that Credit Suisse cut its price target for Cliffs Natural Resources (NYSE: CLF) to $1, I was astonished. I wondered how did they come up with this number. So I decided to paint a picture of the worst-case scenario.
Here's what I came up with. In this scenario, Cliffs shuts the Bloom Lake mine and incurs $140 million of annual expenses related to the shutdown. Cliffs is unable to sell neither coal mines nor Australian iron ore assets. Cliffs' U.S. iron ore segment realized prices drop to $90 per ton, and the company is unable to improve its cash cost, which stays at $65 per ton. Cliffs' Australian segment and coal assets contribute nothing to the company's EBITDA. Also, the company is not able to refinance any of its debt and could rely only on the $1.125 billion credit facility.
In this scenario, Cliffs could rely only on its U.S. operations to sustain its debt and capital spending. Based on current run rate, Cliffs' U.S. operations are likely to produce 8 million tons of iron ore next year. Given the above-mentioned assumptions, the company will get $200 million from its U.S. assets in 2015. Also, the company will have the additional $175 million cash from the sale of the Logan County Coal. Meanwhile, expenses including dividend, interest expense, Bloom Lake mine closure costs, capital spending and SG&A expenses could total around $800 million. Thus, there will be a $425 million gap in cash flows, which will have to be financed from the credit facility. The dividend elimination and the ability to solve the Bloom Lake mine problem could narrow this gap to roughly $200 million.
There is one thing that I'd like to point out in this scenario. The scenario implies that the management does nothing: no improvement on costs, no asset sales, no legal work to get rid of the Bloom Lake mine costs. The recent results do not support such a premise. Despite tough met coal price environment, the company was able to arrange a sale of Logan County Coal. Cash cost at Australian operations declined from $53.38 per ton in the second quarter to $52.36 per ton in the third quarter. Cash cost at U.S. iron ore operations declined from $66.73 per ton in the second quarter to $64.87 per ton in the third quarter. In addition, Cliffs' has a $200 million buyback authorization, which could be used if Cliffs' shares dive further. All in all, I think that the presented scenario is unrealistic. I view the $1 per share price target as unrealistic as well, and remain neutral on Cliffs.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.