Down 40% This Year, Can Cliffs Natural Resources Claw Its Way Back?

Source: Cliffs Natural Resources.

Another day, another $100 million cut to capital expenditures. That's seemingly the routine at Cliffs Natural Resources (NYSE: CLF  ) , which announced last week it would reduce its spending program once more, on top of the $460 million in reductions it previously declared. While the iron ore miner tries to fend off a collapsing market for the steelmaking raw ingredient, it also needs to fight a rear guard action to stave off activist shareholders upset at the value destruction they've witnessed.

Cliffs said on May 27 it was cutting its 2014 capital spending by 25%, dropping the total to between $275 million and $325 million, with the eastern Canadian iron ore and North American coal segments taking three quarters of the reduction. Previously the miner slashed its capital budget by more than half from the $862 million it spent last year.

The spending cuts are being driven by the recent volatility in seaborne iron ore and metallurgical coal pricing, according to a Cliffs press release.

China consumes roughly two-thirds of the 1.2 billion ton global seaborne trade, with roughly one-fifth coming from Australia's Port Hedland. But a supply glut has depressed pricing, and the situation isn't much better for metallurgical coal.

It's estimated the average cost of production is $101 a ton. However, pricing lately from Australia runs around $105 to $120 a ton, though a lot depends on how the biggest miner, BHP Billiton (NYSE: BHP  ) , manages its operations. Some reportedly have asked it to cut output so as not to depress pricing further, but the miner says it will continue to run at capacity.

Cliffs indicated that it expects the pricing environment to remain volatile over the near term, which will directly impact revenue in the majority of its business segments. However, it expects the long-term supply contracts in U.S. iron ore, Cliffs' largest and most profitable business segment, will significantly offset the impact on revenue of lower seaborne iron ore prices. Casablanca Capital isn't so sure, worrying the miner may breach its debt covenants. 

The hedge fund launched a drive in January to clean house at Cliffs, announcing its intention to replace the entire board of directors. Following the miner's capex announcement last week, Casablanca, which owns about 5% of Cliffs' stock, said it was looking to make further changes, including litigation if necessary, to protect shareholder interests.

The shareholder thinks Cliffs should bundle its troubled but still promising Bloom Lake project in eastern Canada with its international assets and spin them off into a separate company called Cliffs International. The remaining U.S. assets should be placed into a master limited partnership that would pay a dividend double its current size. Management has rejected the proposals.

Casablanca is not alone in its worries about Cliffs' debt covenants. RBC Capital Markets says Cliffs is treading water, but could breach its agreements if pricing deteriorates further.

The fact that the miner is in such a situation is proof to Casablanca that management has been a poor steward and is only interested in preserving its power base. When Cliffs filed its annual shareholder meeting notice, it stated that approval of Casablanca's board nominees may be considered a change of control of the company, triggering a so-called "proxy put" that would require it to repurchase all of its outstanding notes and plunge the company into a liquidity crisis. The hedge fund calls that claim a straw man and indicative of the tactics management is willing to use to wrangle votes out of investors.

Casablanca says the whole issue can be sidestepped if Cliffs approves its nominees for the board. Management does not have to support them, but the proxy put would only be triggered if it remains an adversarial relationship. 

Cliffs Natural Resources stock has lost 84% of its value since peaking in 2011. Last year, it was the second-worst performing stock on the S&P 500 -- from which it was ejected in March -- and shares have lost another 39% year to date.

Cliffs' situation is not necessarily of its own making, but actions it takes, or doesn't, could exacerbate the crisis. Not only might Cliffs go over another cliff, it might just find itself in a hole it won't be able to climb out of.

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