Cliffs Natural Resources: What If Management Wins?

What should we expect from Cliffs Natural Resources stock if management retains control of the board?

Jul 2, 2014 at 11:05AM

On July 29, Cliffs Natural Resources (NYSE:CLF) will hold its annual shareholders meeting. All annual shareholders meetings are important, but some are more important than others. In Cliffs Natural Resources' case, the 2014 annual shareholder meeting will likely decide the future of the company.

The future of Cliffs Natural Resources is at stake because 5.2% owner Casablanca Capital will try to take control of the company's board during the meeting. Casablanca Capital wants Cliffs Natural Resources to focus on its U.S. iron ore division and spin off and/or sell the other divisions.  

Management's plan, on the other hand, is to stay the course and cut costs as much as possible. To accomplish this, management idled the unprofitable Wabush mine and delayed Phase II expansion of Bloom Lake. Management also plans to reduce capital expenditures by 64% year over year and consider strategic alternatives to the Bloom Lake Mine. 

Cliffs Natural Resources management is also willing to hear what Casablanca Capital has to say and has agreed to give Casablanca Capital representation on the board. Management does believe, however, that Casablanca Capital's plan is short sighted. Management believes that iron ore prices will rise in the long term as China and other emerging countries urbanize. If iron ore prices rise, selling assets at a low point in the commodity cycle would be a mistake. 

So what would happen to Cliffs Natural Resources stock if management were to retain control of the board?

Well, likely not much. The company's share price depends on iron ore prices, which depend on the state of the Chinese economy. 

For Cliffs Natural Resources' fundamentals to improve, iron ore prices have to rise. And iron ore prices depend on how the Chinese government navigates the credit bubble and whether the government aims for a soft landing or launches another round of stimulus. Iron ore prices also depend on when higher-cost Chinese iron ore producers shut down and whether iron ore giants like BHP Billiton Ltd. (NYSE:BHP) and Rio Tinto (NYSE:RIO) increase their production. 

As for when iron ore prices may rise again, analysts are unsure. Goldman Sachs believes that there will be a worldwide iron ore seaborne surplus of 72 million tons in 2014 and 175 million tons in 2015. That surplus means that Cliffs Natural Resources management may have to wait at least until 2016 before the cycle turns up. 

Another consequence of management retaining control of the board may be a reduced dividend. By taking the long-term view, management believes that its principle job is to preserve the balance sheet and ride out the cycle. This means preserving liquidity. At the end of Q1 2014, the company did have sufficient liquidity of $1.9 billion. But Wells Fargo believes the Cliffs Natural Resources is burning cash at a $220 million a year pace. If iron ore prices fall further, cash burn will increase and the company will have to cut the dividend to preserve its liquidity. Management may also have to reduce its dividend to 1 cent per share in any debt renegotiation.

The short term pain may be worth it, however, in the long run if iron prices rise as management predicts. 

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