Cliffs Natural Resources (NYSE: CLF) has recently been pressed by activist investor Casablanca Capital to perform several moves which, in Casablanca's view, would maximize shareholder value. These moves included separating Cliffs' U.S. operations from its international operations, doubling the dividend, converting U.S. assets into a master limited partnership, divesting infrastructure and reducing its expenses.
In response, Cliffs Natural Resources issued an open letter to shareholders, where it discussed why it believed that Casablanca's proposals were unrealistic. Could investors hope for increased cash returns from a company whose stock has been under pressure since 2011 and is down 12% this year?
The number one priority
During the earnings call, Cliffs Natural Resources explicitly stated that its first priority for any additional cash generated over and above capital spending and dividend payments will be the reduction of net debt. The company had more than $3 billion of debt at the end of the fourth quarter. Last year, interest expense was $179.1 million, which clearly dragged the company's earnings down.
I would like to highlight that the company wants to double its cash position to reduce net debt rather than repay some of the existing debt. It looks like Cliffs is uncomfortable with the existing $335 million cash position.
Problems with Canadian operations continue
Cliffs Canadian operations continued to deliver lackluster performance in the fourth quarter. As a result, the company decided to idle the Wabush mine, which had cash costs of $143 per ton, way above current iron ore prices.
Bloom Lake is also a problem, and the company stated that it could be sold or idled if performance did not improve. Bloom Lake's cash cost per ton is expected to average $85-$90 per ton in 2014. Add another $25 per ton for depreciation, depletion, and amortization, and you get a bleak picture.
In comparison, Cliffs' U.S. operations cash costs are expected to be between $65 and $70 per ton. A weaker Australian dollar is helping Cliffs' Australian operations, and cash costs are expected to average $60-$65 per ton in 2014.
Australia is a source of production growth for other iron ore producers like Rio Tinto (NYSE: RIO) and BHP Billiton (NYSE: BHP). Rio Tinto is expecting to produce 295 million tons of iron ore this year, up 11% from last year's figures. BHP Billiton is also active on this front. BHP's latest report showed that it grew its iron ore production by 16% in comparison with 2012. Ironically, production growth from both Rio Tinto and BHP Billiton contributes to existing pressure on iron ore prices.
While Casablanca may wish for the doubling of Cliff's dividend, this is a dream that will not come true any time soon. Iron ore prices remain weak. Cliffs' latest report showed that the January iron ore benchmark price was $128 per ton, down from $135 in the fourth quarter.
Cliffs also has a met coal business, but met coal is under pressure too. Alpha Natural Resources' (NYSE: ANR) latest report showed that weak spot pricing once again translated into contracts. Alpha Natural's met coal 2014 contract price stood at $94.66 per ton. Cliffs' has already committed 50% of its 2014 met coal sales volume at $87 per ton.
Cliffs is going to focus on building its cash position, which looks like a wise thing to do in the current environment. Given this fact and the problems at Bloom Lake, the company is highly unlikely to raise its dividend in the near future.
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