The commodity downturn that started in 2011 was not kind to Teck Resources Ltd (NYSE:TECK) or Cliffs Natural Resources (NYSE:CLF). The problem this pair of miners faced wasn't unique, boiling down to too much debt during an industry downturn. A lot of work has been done to improve their respective outlooks, but the forecast just isn't as clear for Cliffs' business as it is for Teck's. Here's what you need to know.
The mining industry is highly cyclical. When the good times get going, miners tend to plan giant projects to expand production, projecting increasing demand well into the future. But mining projects cost a lot of money and take a long time to complete. And since they don't provide any cash flow until they start producing, getting from the drawing board to an operating mine usually requires taking on a lot of debt. When the good times end, that debt can be a huge burden. Too much debt at the wrong time is pretty much the story of Cliffs Natural Resources.
By the time that the commodity downturn hit in 2011, Cliffs' debt had ballooned to $3.6 billion. That was more than a 100% increase over the $1.7 billion in debt with which the company started the year. At that point debt was around 40% of assets, excluding non-controlling interests. That's not unreasonable, unless something goes wrong (like a commodity downturn).
The downturn pushed Cliffs' earnings from $11.48 a share in 2011 to a loss of $6.32 in 2012. Debt peaked in 2012 at $3.96 billion. As Cliffs worked to deal with the issues it faced in the market, it made the choice to focus on iron ore and get out of other businesses, like steelmaking coal. That led to massive asset writedowns that pushed shareholder equity deep into the red in 2014, with a further decline in 2015.
Debt was falling through those years. By the end of 2015, long-term debt stood at around $2.7 billion -- an impressive 30% decline in just a couple of years. But because of the write-offs, Cliffs' shareholder's equity was negative, meaning that debt was (and still is) more than 100% of the capital structure.
The trends are going in the right direction, but the company's still not out of the woods yet. For example, Cliffs' debt stood at around $1.6 billion at the end of the first quarter, down almost 60% from its peak in 2012. An upturn in the commodity markets, meanwhile, allowed Cliffs to sell stock in 2016 and during the first quarter of 2017. Those stock sales, along with getting back into the black in 2016, helped to trim the shareholder equity deficit from nearly $2 billion at the end of 2015 to a deficit of $830 million at the end of the first quarter of 2017. So things are definitely getting better, but there's still a lot more work to be done on the balance sheet.
A better foundation
Basically, Cliffs remains a turnaround situation, which is why most investors would be better off owning Teck Resources. At the end of the first quarter, long-term debt made up around 30% of the miner's capital structure, excluding non-controlling interests. Shareholders' equity was soundly in positive territory and never dipped into the red even during the worst of the downturn.
An important reason for that was Teck's more diversified business model, which includes steelmaking coal, copper, and zinc. That said, long-term debt didn't peak at Teck until 2015 (at around 37% of the capital structure), partly because of the financial costs associated with Teck's 20% stake in the Fort Hills oil sands development, which is being led by oil sands expert Suncor Energy. Investors were, rightly, concerned that Teck would have trouble coming up with the money for the project during a commodity downturn.
Those fears have passed. And, notably, debt has been reduced by roughly 30% since the end of 2015. Teck's oil investment, meanwhile, is expected to start producing oil in late 2017 with a full ramp-up over the next 12 months. The cash drain from the project will soon turn into cash production. The miner's portfolio will also expand from three commodities to four, making it an even more diversified company.
Putting it all together
So when I look at Cliffs and Teck, I see two companies that are working toward better futures. But Cliffs is still trying to pull itself out of a deep balance-sheet hole -- something that's going to take a little longer to achieve. If you like turnaround stories, that might interest you. However, most investors would be better off with Cliffs, which has kept its balance sheet healthy. Moreover, its future looks increasingly bright now that oil is expected to start flowing from Fort Hills in the next six months, taking this diversified miner from three commodities to four.