The Inglorious Fall of Cliffs Natural Resources

When I was a younger lad living in the Amazon rainforest, in place of an outhouse, we had the edge of a cliff. I kid you not, and it was actually fairly dangerous. After reviewing and absorbing third-quarter earnings from miner Cliffs Natural Resources (NYSE: CLF  ) , I'm recalling that sensation of being one misstep away from a most inglorious fall.

Existing Cliffs shareholders have been subjected to an inglorious 14% fall since the company reported deeply disappointing earnings this week of just $85.1 million. From the company's prior-year mark of $601.2 million, that's truly a cliff-diving drop. But, in this case, my frequent tendency to perceive Foolish opportunity in the midst of such a deep sell-off just doesn't apply.

A dangerous combination of widespread cost pressures collided with a 36% decline in average prices for seaborne iron ore to yield a gut-wrenching 76% decline in Cliffs' consolidated sales margin. Thank goodness for the solid 32% sales margin from the company's U.S. iron ore unit, because the remaining three business units each posted a negative sales margin! Unfortunately, pursuant to Cliffs' unsettling outlook for slightly weaker domestic steel mill capacity utilization in 2013 than the already-painful business conditions here in 2012, the company guided for a 9% to 14% reduction in 2013 production volume, from its one unit that produced a positive margin in the third quarter. With that dip in production comes the threat of cost escalation, placing at risk some portion of the company's final bastion of healthy margin performance.

Rising labor costs, maintenance expenditures, and lower-grade ores at the Australian operations all contributed to Cliffs' third-quarter margin malaise. In Australia, the development of new open pits diverged from expectations, and required the miner to move "nearly 50% more material compared with the prior year's third quarter," in order to realize a 20% increase in production volume. This condition of elevated stripping ratios and prevalence of low-grade material looks set to continue into 2013, and threatens to present continued margin pressure.

With Chinese steel imports flooding the domestic market, and the recent round of sobering economic assessments from key industrial bellwethers, I believe Cliffs is facing the prospect of some sustained weakness in iron ore, and met coal prices that could persist well into 2013. Facing further cost pressures, capital expenditures relating to ongoing expansion of its Bloom Lake mine, and just $36 million in cash at the end of the third quarter -- (and $3.9 billion in debt!) -- I believe the company's popular dividend is in serious jeopardy. For all the above reasons, I encourage investors to steer clear of Cliffs Natural Resources until the company gets back on more sound operational and financial footing. Accordingly, I have closed my prior bullish CAPScall on the stock at a substantial 34% loss.

Fortunately, investors looking to gain exposure to a resiliently bullish long-term outlook for met coal and iron ore prices still have an array of compelling and well-positioned options to choose from. I've recently laid out my rationale for holding shares of Teck Resources (NYSE: TCK  ) for the next 20 years, and it relates primarily to the miner's world-class met coal assets.

Peabody Energy (NYSE: BTU  ) is my king of coal, not only for its position within the best-looking regions of a challenging domestic coal market, but also for its alluring capacity to supply the Pacific seaborne market with quality met and thermal coals. For iron ore, I hold small positions in Vale (NYSE: VALE  ) , and imminent European producer Northland Resources (ticker "NRSRF" on the over-the-counter exchange), and have been tracking Rio Tinto (NYSE: RIO  ) lately as a potential buying opportunity. To join me in monitoring these volatile and complex commodity markets for signs of Foolish opportunity, please bookmark my article list or follow me on Twitter.

Looking for more commodities-based ideas? Download The Motley Fool's special free report, The Tiny Gold Stock Digging Up Massive Profits. Our analysts have uncovered a little-known gold miner that they believe is poised for greatness; find out which company it is and why its future looks bright -- for free!

Fool contributor Christopher Barker owns shares of Northland Resources, Peabody Energy, Teck Resources Limited, and Vale. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On October 30, 2012, at 7:21 AM, skypilot2005 wrote:

    Sinchi,

    Speaking of Met. Coal, have you perused Novadx recently?

    New C. E. O., Sandstorm heavy management involvement, quality assets.

    Here are a few “links”:

    Mr. Daniel A. Roling was appointed as President, Chief Executive Officer, Director of NovaDX Ventures Corporationrationration with effect from September 21, 2012. Mr. Roling was previously the president and CEO of National Coal Corporationration, a southern Appalachian coal producer, from August, 2006, until it was sold in December, 2010. While at National Coal, Mr. Roling restructured the management team and the assets, improving the operating efficiency and financial health of National Coal while significantly increasing the reserve base and doubling coal production. Prior to serving at National Coal, Mr. Roling was first vicepresident and global senior metals and mining analyst at Merrill Lynch, where he was employed for 25 years. Mr. Roling is both a certified public accountant and a chartered financial analyst, and is a longstanding member of the National Coal Council, which reports directly to the Secretary of the Department of Energy

    http://www.novadx.com/

    NDX.V

    OTC: NDXFF

    About Novadx: Novadx Ventures Corp. is a Vancouver based mining investment company. Through its wholly owned subsidiary, Novadx's primary focus is to invest its capital to acquire and develop companies with active or near production high quality coal reserves in the US Appalachia coal region. Novadx intends to continue to grow the value of its coal investments through expanding production and reserves amongst its existing investments and by investing in additional acquisitions. Novadx is actively evaluating a number of high quality coal acquisition opportunities. For more information please visit www.novadx.com.

    Novadx, through its wholly owned subsidiary MCoal Corporation ("MCoal") is:

    Operating the “Rosa” mine located in Blount County, Alabama. The Rosa Mine produces a high quality coal for the metallurgical and activated carbon coal markets.

    Developing the “Rex No. 1” mine located in Campbell County, Tennessee. MCoal expects to begin operating this mine in the third quarter of 2011. The Rex No. 1 mine will produce a high quality coal for the metallurgical, silicon metal and industrial stoker coal markets.

    http://www.novadx.com/index.php?option=com_content&view=...

    10/18/12

    Novadx Announces the Appointment of Marc Solochek to the Board of Directors

    http://www.novadx.com/index.php?option=com_content&view=...

    Novadx and Sandstorm Agree to Acquire Additional Rex Coal and Related Assets in Tennessee

    10/17/12

    Sky

    Your Official Web Link Assistant in an unofficial capacity

    Fellow Fools: This may be viewed as a highly speculative stock. Do your own D. D. I own a “chunk” of it.

  • Report this Comment On October 30, 2012, at 5:46 PM, Sturmudgeon wrote:

    Regarding your interest in Rio Tinto, they are having what appears to be real problems in Mongolia. Just in case you hadn't heard.

    Best regards,

    Stirling

  • Report this Comment On October 30, 2012, at 11:54 PM, skypilot2005 wrote:

    http://www.businessweek.com/news/2012-10-29/sandstorm-bets-o...

    Sandstorm Bets on Buying Not Finding Gas, Gold

    By Christopher Donville on October 29, 2012

    Watson co-founded Sandstorm Gold to buy bullion from mining companies in so-called streaming deals that pay in advance for a percentage of output at a discounted fixed price. He then sells the gold to reap the spread between the purchase price and the spot price. Watson set up Sandstorm Metals & Energy Ltd. (SND) in 2010 to apply the same financing model for companies in non-precious metals, oil and gas.

    “I firmly believe it will be the larger of the two entities in the long run just because the space is so much larger,” Watson, 33, said in an Oct. 25 interview at his Vancouver office. “The companies are bigger, the mines are bigger, there’s more of them and we’re going to take advantage of that.”

    Hmmm....

    Sky

    Looooong both Sandstorms

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