Cliffs Natural Resources: Turnaround is a Pipe Dream

The plunging iron ore prices have taken a toll on all miners, and Cliffs Natural Resources (CLF) is no exception to it. The stock has lost over 85% value since I first recommended selling it in almost two years ago, and I believe this trend will continue in the near future.

The falling iron ore prices have had a massive negative impact on Cliffs as the company is burning through cash at a rapid pace. In Q2FY15, Cliffs reported earning per share of -$0.21, $0.09 less than what the analysts were modelling.

The company revenue of $498 million also missed the analyst estimate of $572.34 million.

What makes the matters worse is the fact that Cliff is running out of cash. The company completed a secured debt offering of $540 million at an interest rate of over 8.2% less than five months ago. However, Cliff ended the most recent quarter with cash and cash equivalent came of $276.2 million. Given the high rate of interest, and the speed at which Cliff is burning cash, the company’s debt is likely to increase in the coming quarters.

Iron ore price act as a major headwind for Cliff as it fell 30% in the past few months. And with the demand for iron ore weakening due to an economic slowdown, I don’t think this trend will reverse in the near future. In fact, prices may fall further as suggest by analysts at Goldman Sachs. In a recent report, Goldman Sachs stated:

"The structural drivers of the iron ore price trump cyclical drivers and they are unchanged since mid-2014: demand is lackluster, supply growth continues and prices must overshoot on the downside to force high-cost mines to close,"

The company’s coal sale is a plus point, but not enough to overcome the consequences faced by constant dip in iron ore imports. Cliffs’ initiatives like reducing cost to maintain their balance in the weak end market will not be fruitful as it possess ten times greater debt than its free cash flow.

Cliffs’ cash capital spending and SG&A expenses dropped 70% and 25% to $19 million and $31 million respectively on a y-o-y basis. The company is trying to maintain its balance sheet by implementing cost-cutting actions and selling of non-core assets. The company is making efforts to shut down its idled iron ore trade assets, railways, and port facilities to withdrawal its Eastern Canadian Iron Ore business. The management mainly focuses on reducing debt, but the company’s long term debt is precariously high. Thus, these efforts will not be able to offset the loss incurred due to the falling iron ore prices.

Conclusion

Cliffs share priced jumped almost 20% today as the company announced it has terminated its Pellet Sale and Purchase Agreement with Essar Algoma. However, the company’s long-term prospects are still very dim. Cliffs’ balance sheet is deteriorating and given the high rate of interest of its secured debt, I believe things are about to get worse for the company. Thus, I think investors should use the pop to short the stock.

Published on Oct 10, 2015
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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