By Mike Thiessen - May 8, 2013 | Tickers: BHP, CLF, RIO | 0 Comments
Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Once a darling of fund managers and retail investors alike, Cleveland-based Cliffs Natural Resources (NYSE: CLF) has suffered an epic share-price collapse as well as a number of strategic setbacks. Buffeted by low market prices for its core iron ore and coal products and slackening demand from emerging-market customers in China and elsewhere, the company has had to implement several painful cost-control measures to shore up its finances.
Even worse, its much-touted acquisition of the Bloom Lake mine complex in Quebec has thus far provided disappointing results. Cliffs has delayed a key expansion at the mine and has given only vague guidance about when these activities might resume. Given the high hopes that the company expressed for Bloom Lake as recently as June of 2011, this comes as a serious setback. Shareholders have punished the firm by pushing its price-to-book ratio below 0.6. If Cliffs cannot turn around its fortunes soon, more drastic steps may need to be taken.
Financial Comparison with the Competition
As a major producer of basic raw materials like iron ore pellets, coking coal and lump ore, Cliffs competes with some of the largest and most recognizable names in the mining industry. These include London-based Rio Tinto (NYSE: RIO) and Melbourne-based BHP Billiton (NYSE: BHP).
Both Rio and BHP Billiton are substantially larger than Cliffs. With a market capitalization of $2.6 billion and gross 2012 revenues of less than $5.9 billion, Cliffs pales in comparison to Rio's $85.2 billion market cap and $51 billion revenue haul. For its part, BHP has a $176.2 billion market cap and $67 billion in revenues.
Although Cliffs' profitability is in the gutter, Rio is having its own set of problems. In 2012, Cliffs lost about $935 million to Rio's loss of about $3 billion. These figures produced negative profit margins of 6.1% and 15.3%, respectively. Meanwhile, BHP was broadly profitable with after-tax 2012 earnings of $9.6 billion and a positive margin of 14.4%. All three of these companies are highly leveraged, but Cliffs is by far the worst off. The company has under $200 million in cash and a debt load of $4.3 billion. It also bled $500 million in cash during the last fiscal year. BHP and Rio both have at least $5 billion in cash to fall back on.
What Went Wrong?
There is no easy scapegoat for Cliffs' woes. Broadly speaking, the company is invested in two categories of basic materials that have fallen in price as a result of excessive supply and slackening demand. Many observers point to China's weaker-than-expected economic growth and sudden emphasis on growing its economy's service sector.
The Bloom Lake acquisition has also produced an unending series of headaches. Even before announcing its decision to delay the expansion of Bloom Lake Phase II, Cliffs had warned shareholders that it would need to invest another $400 million to achieve full production at the facility. Shareholders who had taken the company's promise of 8 million tons of consistent annualized production at face value were not expecting to hear of these setbacks. At this point, Cliffs's shareholders are simply hoping that the company will be able to complete its expansion within the next 18 months. For some examples of more promising investments in the metals sector, click here.
Potential Solutions
Cliffs' management team is clearly in crisis mode, and it has taken some concrete steps to shore up its balance sheet. It has partially or fully stopped production at two under-performing U.S. iron ore mines and halted operations at a key pellet-producing facility as well. Although its coal operations continue apace, further furloughs at its mines in West Virginia and Alabama are not out of the question.
Although Cliffs recently beat market-watchers' reduced earnings expectations, it has run into a snafu at another of its Canadian facilities. Indeed, a dispute with Ontario's premier over their Black Thor property threatens production there on a permanent basis.
Long-Term Outlook and Possible Plays
It remains unclear whether these important cost-cutting measures will be enough to turn around Cliffs' fortunes. Most industry observers do expect iron ore prices to make a meaningful recovery during the next two years however out-year price forecasts remain soft due to unclear levels of demand for structural steel. Coal prices are another matter entirely. Since environmental regulations and competition both weigh heavily in this space, things could go either way.
If it proves unable to arrest its stock-price decline and provide shareholders with some indication that it has a clear plan for the future, Cliffs could soon become a takeover target for a larger mining company. Given their size and relative health, Rio Tinto and BHP Billiton look to be the two most likely buyers. Both companies operate in the iron ore space and enjoy substantial operational overlap with Cliffs. Regardless of which giant ultimately absorbed the smaller firm, consolidation would surely follow.
In sum, it is by no means assured that Cliffs will become an acquisition target for a larger firm however its current financial path is unsustainable. Although investors may wish to play its stock for a short-term bounce, such a move would be risky in light of continuing unease about the state of the global market for steel. Indeed, investors may wish to wait to buy in until receiving some definitive news about whether Cliffs intends to remain independent.
Cliffs Natural Resources has grown from a domestic iron ore producer into an international player in both the iron ore and metallurgical coal markets. It has also underwhelmed investors lately, especially after its dramatic 76% dividend cut in February. However, it could now be looked at as a possible value play due to several factors that are likely to remain advantageous for Cliffs' management. For details on these advantages and more, click here now to check out The Motley Fool's premium research report on the company.
