What's Next for Cliffs Natural Resources Inc?

Cliffs Natural Resources continues to battle pricing headwinds with capital spending cuts.

Jun 1, 2014 at 10:42AM

Months go by, but still iron ore and met coal prices show no signs of a rebound. This is bad news for Cliffs Natural Resources (NYSE:CLF), which produces both iron ore and met coal. The company continues to battle costs, as it swung to negative operating cash flow in the first quarter. Back in April, the company announced a voluntary delisting from Euronext Paris in order to cut spending. More recently, Cliffs Natural Resources revealed more significant news -- a $100 million reduction in capital spending.

Spending cuts across the board
Prior to this announcement, Cliffs Natural Resources already cut its capital spending by 55% from last year's figure. The new capital spending estimate is reduced by another 25% to $275 million-$325 million. Cliffs Natural Resources indicated that this range is a sustainable level to support the company's production volume and cash-cost expectations. In other words, the company is unlikely to go lower than that.

Cliffs Natural Resources is not the only mining company that cut its capital expenditures to sustainable levels. Walter Energy (NASDAQOTH:WLTGQ), which is a pure met-coal play, lowered its capital spending to $130 million amid continued weakness in met-coal prices. 

There is little chance that Walter Energy will be able to push spending lower than this number. Still, this drastic spending reduction has so far failed to reassure investors, and Walter Energy's shares are down 67% year to date.

Another met coal producer, Alpha Natural Resources (NYSE:ANR) also lowered its capital spending guidance to $225 million-$275 million from a previous range of $250 million-$300 million. Just as in Walter Energy's case, this move did not give much faith to Alpha Natural Resources shareholders, who are concerned about the prolonged met coal price weakness. As a result, Alpha Natural Resources shares have lost 48% year to date. 

Dealing with underperforming segments is key
Could this further reduction in capital spending be a game-changer for Cliffs Natural Resources? The company must deal with its underperforming segments. While its U.S. iron ore and Asia Pacific iron ore operations are operating at positive margins, the Eastern Canadian iron ore and North American coal segments are dragging the company's results down.

No wonder that 75% of the $100 million capital spending reduction is attributed to these two segments. Eastern Canadian iron ore had a negative $50 million sales margin in the first quarter, while North American coal lost $48 million. One of the reasons for this was the fact that production exceeded sales in both segments, but higher costs also took their toll.

Going forward, both segments have better chances to show positive cash flow with reduced capital spending and increased sales. This point is important for income-oriented investors, as Cliffs Natural Resources' dividend could be reduced should the company's financial position deteriorate.

So far, this scenario does not look probable in the near term. Despite pricing problems, the U.S. iron ore and Asia Pacific iron ore segments should be able to deliver solid results and offset pressure from underperforming segments.

Bottom line
Cliffs Natural Resources' ability to curb capital spending is a positive sign. However, the company remains vulnerable to further iron ore and met-coal price downside. It looks like Cliffs Natural Resources is very close to cost-cutting limits in its underperforming segments. Another drop in prices will force the company to make tough decisions and either close weak operations or cut the dividend.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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