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Why You Should Stay Away from Rio Tinto and Cliffs Natural Resources

April 30, 2014 | About:
FinanceGuru

FinanceGuru

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It was a tough year for most mining companies in 2013. Metal prices have dropped and there are little or no signs of a rebound. The drop in metal prices has had a big negative impact on the likes of Cliff Natural Resources (CLF) and Rio Tinto (RIO) as the companies’ stocks have fallen considerably. The companies are taking certain steps to turn around their fortunes. Let’s take a look at their prospects.

Initiatives

The iron ore business is key for other companies such as Rio Tinto and Cliffs Natural Resources (CLF) as well.

Rio Tinto generated roughly 84% of its earnings from the iron ore business and has been resorting to similar tactics as Vale, but has been unsuccessful in its attempt to sell its assets.

The present year has been dismal for Rio as its share prices have reduced approximately 20%, while its quarterly performance hasn't been great either. The company's earnings dropped $1.3 billion to $4.2 billion while cash flow from operations remained flat at $8 billion. The drop in overall average prices of materials was the key factor for this drop.

To make up for the plunge in material prices, the company is planning to replace its train drivers with robots. There are more than 400 workers who get paid $224,000 per year, replacing them with robots will save the company nearly $100 million. The company is aiming to reduce the transportation costs to $15.60 per ton by 2020, from $23.10 per ton in the present year and this automation of trains should help the company achieve its goal.

The drop in material prices has affected almost all the companies and Cliffs Natural Resources is no exception. In fact, the company has fared far worse than Rio and Vale as its share price has dropped more than 50% year-over-year. Also, Cliffs reported a drop of 6% in its revenue, while operating income dropped 28% to $262 million. On the earnings front, the company's bottom-line came crashing down from $258 million in the second quarter of 2012 to $133 million in the present year.

Though the company is focused on its iron ore business, it generated about 17.6% of its revenue from met coal. Cliffs has also been pretty inactive on the assets selling front and it doesn't look like it'll change in the foreseeable future. The company has only managed to sell its minority stake in Amapa iron ore operations and given that all companies are concentrating on the iron ore business, this deal will do more harm than good.

Cliffs is also trying to reduce its overheads to $215 million from $230 million by focusing on improving its cost structure. The company is also planning to reduce its exploration expenses by $10 million to $75 million.

Conclusion

So, the outlook for Cliffs doesn't look bright at all right now, especially considering that the company has a massive debt burden of $3.26 billion while its cash position is quite weak at just $335 million. Also, a look at the P/E ratios indicates that Cliffs' earnings are expected to decline. While its trailing P/E ratio is 8.80, the forward P/E ratio is quite high at 18.63. Hence, considering all these factors, I think it is best to stay away from Cliffs.

Rio, on the other hand, doesn’t look good either. Analysts are estimating a 9% dip in Rio’s earnings from 2014 to 2016, taking into account the lower iron ore prices that will offset increased production and cost cuts made by the company. The headwind for the miners come from the oversupplied iron ore market and slowdown in demand from China in the future. Falling earnings and revenues will impact the company's financial position in the coming years, as it is already carrying a large debt. Considering these factors, the company does not seem to be able to sustain its dividend increases in the coming years, especially since it already has a very high dividend payout ratio. Hence, investors should stay away from both these miners.


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