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Here's Why Cliffs Natural Resources Doesn't Look Like a Worthy Investment

June 19, 2014 | About:
rusticnomad

rusticnomad

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Cliffs Natural Resources (CLF) has been sailing through troubled waters for quite some time on account of weak iron ore prices. As a result, the mining and natural resources company had to cut its dividend by a massive 76% last year. But, management has adopted a cost cutting strategy to bring the company back on track.

Key strategies

As a result, Cliffs has suspended its Chromite project for an indefinite period of time. This would help the company reduce its cost by $45 million. In addition, management is taking various strategic moves as it has idled its underperforming assets, paid down debts, and increased liquidity that will reduce its cost by more than 50%. It has already been successful in reducing costs in both Asia-Pacific iron ore and North American coal, and with these moves it will be able to further reduce its losses.

According to management “growth will come after the successful demonstration of improved performance with its currently-owned assets.” Going forward, the company is evaluating various options that will enable it to generate attractive returns, as well as benefit its shareholders in the long run.

Improving conditions

We can also see some improvement in the economic conditions in the U.S., along with higher auto production, rise in building construction, and other fundamentals that will support domestic steel production and also increase demand for other steel related raw materials. The company expects that demand for iron ore could increase this year.

An improvement in the economic conditions in other regions can be seen as well. China, which is the world’s second-largest economy, is expected to see strong demand this year, including for iron ore. But there are certain issues that may spoil this growth, such as the tightening measures in China that have constrained growth in the near-term. But, management believes that these short-term pains will yield results in the future and increase demand for steel making raw materials in the long run.

Concerns

In spite of these supporting figures, the overall outlook for iron ore does not seem to be promising for the current fiscal. According to a report in Bloomberg, “Australia, the largest exporter of iron ore, has cut its price estimate for this year and predicted a further drop in 2015. Iron ore fell into a bear market this month on speculation that slowing economic growth and credit concerns in China, the biggest buyer, may curb the expansion in demand just as global supply increases.”

Therefore, from a short term perspective, Cliffs may have to face some tough challenges as the iron ore market remains depressed.

Long-term focus

But, management is more focused on a long term perspective and as a result, it is maximizing its free cash flow and reducing net debt. Also, Cliffs would undertake only those projects that require minimal capital spending, such as Bloom Lake, until it finds the option that would extract the highest value for shareholders. It is also evaluating various alternatives for the sale of its assets.

Bloom Lake is a comparatively small project, but even in that, management aims to reduce the operating cost as much as possible. Talking about numbers, Bloom Lake’s production volume has averaged over 500,000 tons of concentrate per month. Although the values may seem to be big, but still, they are below expectations and cash cost is unacceptably high, so maintaining production is a critical step.

In another strategic move, Cliffs has also decided to stop its Wabush Scully Mine, as management was unsuccessful to reduce costs after many failed attempts. This would save around $100 million in cash in 2014.

Conclusion

Although the company has positive prospects, and management has various strategic moves under its sleeve, but as of now, Cliffs doesn’t look like a good buy. The company has a debt of $3.26 billion, while its cash position is quite weak at just $335 million. Currently, it has a trailing P/E of 8.8, but its forward P/E is disappointing at 18.63. This indicates that its earnings would decline in the future. Considering all these factors, it would be wise for investors to avoid Cliffs.


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