Cliffs Natural Resources' Turnaround is a Pipe Dream

Shares of Cliffs Natural Resources (CLF) have staged an impressive turnaround in the last few days. The stock has gained almost 25% on the back of better-than-expected quarterly results. However, Cliffs Natural Resources is still down about 80% since I recommended selling it two years ago.

The company posted Q3 results towards the end of last month affirming narrower-than-expected losses. Cliffs’ EPS of -$0.10 hammered the analysts estimate by $0.12, while top-line of $593 million was also ahead of the consensus target of $591.97 million.
Cliffs Natural Resources’ apparent stunning quarter was greatly driven by widespread cost cutting efforts including salary reductions and the sale of non-core assets. The company’s overhead costs fell 55% y-o-y, and it also slashed its2015 capex plan to $85 million-$95 million from its earlier view for $100 million-$125 million, and reduces its 2015 overhead outlook by $10 million to $110 million.

I have always been of the opinion that cost cutting can never be a long-term driver of share price. Although Cliffs has no other option in the tough environment conditions, the stock is still in troubled waters. I don’t think Cliffs can survive the present commodity crash by cutting costs.

The primary reason why I think Cliffs Natural Resources will struggle is that the company is highly leveraged. Cliffs ended the quarter with $2.80 billion in debt as compared to cash of $270 million. Moreover, a large portion of Cliffs’ debt has an extremely high interest rate that offsets progress of its cost-cutting efforts.

In addition, Cliffs also has a high dividend yield of over 16%. I don’t think spending money of dividends is the way to go. With Cliffs running out of ways to cut back on expenses, investors should expect an extreme dividend slash in the near future.

What makes the matters worse for Cliffs Natural Resources is the fact that iron ore prices are expected to stay low. According to Citibank analyst Brian Yu, the iron ore market is expected to remain challenging in 2016. Yu said: “CLF is making good progress lowering cost where they have control, including SG&A and capex, but market conditions remain challenging and Citi is forecasting a further decline in [iron ore] pricing to $41/ton in 2016."

Conclusion

All in all, things don’t look good for Cliffs Natural Resources going forward and investors can benefit from the recent rally by shorting the stock. The company is still wasting money on dividends and high interest expenses, and is running out of ways to cut back on overheads. Given that the company is highly leveraged and that the iron ore market is expected to struggle for another year, I think Cliffs Natural Resources’ recent rally will be short-lived and the stock will fall to under $2 in the coming months. Thus, I think investors should short the stock.
Published on Nov 13, 2015
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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