News about fresh lows for iron ore have become commonness. Following the news about another Chinese probe on using metals for financing, iron ore dipped once again, scoring a more than 30% decline year to date. While bigger miners like Vale (VALE +2.04%), Rio Tinto (RIO +1.13%), and BHP Billiton (BHP 0.54%) are still profitable at current levels, smaller players take a hit. Cliffs Natural Resources (CLF 2.06%) is a vivid example, with its shares losing almost 50% of their value since the beginning of this year. As the company's cash flows are pressured by the softness of iron ore and met coal market, another problem could be around the corner for Cliffs Natural Resources shareholders – the dividend cut.
Casablanca Capital drops "doubling the dividend" proposal
Downside in Cliffs Natural Resources shares has sent the company's dividend yield way above 4%. Back in winter, activist investor Casablanca Capital suggested that Cliffs Natural Resources should double its dividend. However, in current conditions, such a raise is impossible, and Casablanca itself seems to have dropped this proposal.
In its latest open letter to shareholders, Cliffs Natural Resources states that Casablanca is focused on pushing Lourenco Goncalves, former CEO of Metals USA, to become Cliffs' executive chairman. What's more, Cliffs Natural Resources states that Casablanca Capital changed its view on solving Cliffs' problems, and is suggesting a potential sale of the whole company. The focus of Casablanca's proposals seems to have shifted, making the whole story messier.
No relief on iron ore side
There are few optimists on the iron ore market nowadays. Lately, Morgan Stanley joined other banks to cut its iron ore price forecast for this year and predicting a further drop next year. In turn, Citigroup thinks that iron ore prices could find support near current levels, as low prices cause further production cuts. However, no one predicts a turnaround in iron ore's fate. In fact, stagnation at current price levels could be seen as a satisfactory scenario.
BHP Billiton, Rio Tinto, and Vale might regret what they have done by flooding the market with supply. While BHP Billiton and Rio Tinto' costs allow these miners some comfort, Vale could be feeling less easy if the iron ore decline extends. The reason for this is simple – Vale faces higher transportation costs to its main customer, China, than BHP Billiton and Rio Tinto.
Debt covenants
Cliffs Natural Resources has certain covenants on its $3.2 billion debt, including a 3.5 to 1.0 debt-to-EBITDA covenant. The company has already swung into negative operating cash flow territory in the first quarter of 2014. As iron ore prices extend their decline, the company's ability to stay within its covenants comes under question.
In this environment, a dividend cut seems plausible. The company has already attacked capital spending, cutting it by an additional $100 million at the end of May. Prior to this, Cliffs Natural Resources announced voluntary delisting from Euronext Paris, which has saved a few pennies for the miner. While the company is working toward reducing its costs, it's running out of available options. As Cliffs Natural Resources discarded Casablanca's proposals regarding divestments, the dividend cut is the next logical step in the company's crusade on costs.
Bottom line
Cliffs Natural Resources is in a difficult strategic situation. While Cliffs' earnings are pressured by low met coal and iron ore prices, the company faces a proxy war with activist shareholder Casablanca Capital. Cliffs Natural Resources will surely avoid cutting the dividend as long as possible, as this move will upset shareholders and put additional pressure on shares. However, as iron ore price softness persists, such a move looks increasingly plausible.
