When I was a younger lad living in the Amazon rainforest, in place of an outhouse, we had the edge of a cliff. I kid you not, and it was actually fairly dangerous. After reviewing and absorbing third-quarter earnings from miner Cliffs Natural Resources (CLF 0.93%), I'm recalling that sensation of being one misstep away from a most inglorious fall.
Existing Cliffs shareholders have been subjected to an inglorious 14% fall since the company reported deeply disappointing earnings this week of just $85.1 million. From the company's prior-year mark of $601.2 million, that's truly a cliff-diving drop. But, in this case, my frequent tendency to perceive Foolish opportunity in the midst of such a deep sell-off just doesn't apply.
A dangerous combination of widespread cost pressures collided with a 36% decline in average prices for seaborne iron ore to yield a gut-wrenching 76% decline in Cliffs' consolidated sales margin. Thank goodness for the solid 32% sales margin from the company's U.S. iron ore unit, because the remaining three business units each posted a negative sales margin! Unfortunately, pursuant to Cliffs' unsettling outlook for slightly weaker domestic steel mill capacity utilization in 2013 than the already-painful business conditions here in 2012, the company guided for a 9% to 14% reduction in 2013 production volume, from its one unit that produced a positive margin in the third quarter. With that dip in production comes the threat of cost escalation, placing at risk some portion of the company's final bastion of healthy margin performance.
Rising labor costs, maintenance expenditures, and lower-grade ores at the Australian operations all contributed to Cliffs' third-quarter margin malaise. In Australia, the development of new open pits diverged from expectations, and required the miner to move "nearly 50% more material compared with the prior year's third quarter," in order to realize a 20% increase in production volume. This condition of elevated stripping ratios and prevalence of low-grade material looks set to continue into 2013, and threatens to present continued margin pressure.
With Chinese steel imports flooding the domestic market, and the recent round of sobering economic assessments from key industrial bellwethers, I believe Cliffs is facing the prospect of some sustained weakness in iron ore, and met coal prices that could persist well into 2013. Facing further cost pressures, capital expenditures relating to ongoing expansion of its Bloom Lake mine, and just $36 million in cash at the end of the third quarter -- (and $3.9 billion in debt!) -- I believe the company's popular dividend is in serious jeopardy. For all the above reasons, I encourage investors to steer clear of Cliffs Natural Resources until the company gets back on more sound operational and financial footing. Accordingly, I have closed my prior bullish CAPScall on the stock at a substantial 34% loss.
Fortunately, investors looking to gain exposure to a resiliently bullish long-term outlook for met coal and iron ore prices still have an array of compelling and well-positioned options to choose from. I've recently laid out my rationale for holding shares of Teck Resources (TECK 0.32%) for the next 20 years, and it relates primarily to the miner's world-class met coal assets.
Peabody Energy (BTU) is my king of coal, not only for its position within the best-looking regions of a challenging domestic coal market, but also for its alluring capacity to supply the Pacific seaborne market with quality met and thermal coals. For iron ore, I hold small positions in Vale (VALE 3.08%), and imminent European producer Northland Resources (ticker "NRSRF" on the over-the-counter exchange), and have been tracking Rio Tinto (RIO 2.37%) lately as a potential buying opportunity. To join me in monitoring these volatile and complex commodity markets for signs of Foolish opportunity, please bookmark my article list or follow me on Twitter.