Cliffs Natural Resources (CLF +3.10%) is doing all it can to survive during a period of much lower iron ore prices, its main commodity. The company has drastically cut costs, suspended an expansion of its high-cost Bloom Lake mine in Quebec, and decided to idle its Pinnacle coal mine in West Virginia.
But despite these measures, the worst may not yet be over for Cliffs. If iron ore prices remain below $100 per ton or fall further, the company may be forced to cut its dividend or even suspend dividend payments altogether -- moves that would likely cause its share price to plummet further.
Downward earnings revisions
Most analysts have already revised Cliffs' earnings estimates downward because of their increasingly bearish forecasts for iron ore prices. Goldman Sachs sees the price of iron ore plunging to as low as $80 a ton by next year, while Morgan Stanley predicts $90 a ton and Deutsche Bank sees iron ore averaging $97 a ton over the period 2014-2016.
With iron ore representing about 85% of Cliffs' revenue, the impact of sharply lower prices will have a huge impact on the company's earnings and cash flows. Not surprisingly, Deutsche Bank recently lowered its 2014-16E EBITDA estimates for Cliffs by 11%-29% and EPS estimates by 46%-84%, based on its bearish forecast for iron ore.
Risks to dividend
Cliffs is especially vulnerable to a prolonged period of low iron ore prices because of its high cost structure. The company's first-quarter cash costs per ton at its U.S. and Eastern Canadian operations came in at $65.42 and $98.45, respectively, which is much, much higher than competitors Vale (VALE +2.89%), Rio Tinto (RIO +0.96%), and BHP Billiton (BHP +1.68%).
Because of its higher operating costs, Cliffs is burning cash at a pace of $220 million a year (including capital expenditures and dividends) at current iron ore prices, according to estimates by Wells Fargo. If prices fall further, this cash burn will accelerate, likely forcing the company to sell assets or reduce its dividend. Cliffs already slashed its quarterly dividend 76% from $0.62 per share to $0.15 per share in early 2013.
Given the company's incredibly high cash burn rate at current iron ore prices, its dividend appears wholly unsustainable without major asset sales. Unfortunately, a sale of its high-cost Eastern Canadian assets is unlikely given the current industry downturn, making a dividend cut the more plausible option. If iron ore prices remain at around $90 a ton, it wouldn't surprise me if the company even suspended its dividend payments sometime in the near future to preserve cash.
Glimmer of hope
On the positive side, however, Cliffs no longer has to worry about violating its debt covenants with lenders. The company's creditors have extended a lifeline by agreeing to amend the terms of the company's existing $1.75 billion unsecured revolving credit facility.
The amendment agreement, announced on June 30, replaces the existing leverage covenant ratio requiring the company to maintain a debt-to-EBITDA ratio of less than 3.5, with a new covenant requiring it to maintain a debt-to-capitalization ratio of less than 45%.
It also raises the company's minimum acceptable EBITDA-to-interest expense ratio from 2.5 to 3.5. These are important developments, since they provide the company with a more reliable source of liquidity during an especially challenging period of pricing volatility.
Investor takeaway
While there are some reasons to be hopeful, it's hard to envision a bright future for Cliffs. The company is heavily exposed to iron ore, a commodity that is likely beginning a multi-year structural slowdown because of a combination of slowing Chinese steel demand and global oversupply.
While Cliffs' decision to slash spending and its recently amended credit agreements should allow the company to avoid bankruptcy, its overwhelming exposure to iron ore and status as a high-cost producer make it difficult to justify a bullish case for the stock.
