Is Cliffs Natural Resources Set for a Short Squeeze?

Cliffs Natural has more than a third of its shares on loan -- have the shorts got it wrong?

Rupert Hargreaves
Rupert Hargreaves
Jul 9, 2014 at 9:05AM
Energy, Materials, and Utilities

With 34% of Cliffs Natural Resources' (NYSE:CLF) float short, the company is a prime candidate for a short squeeze.

However, with the price of iron ore collapsing and no resolution in sight for Cliffs' problems, or its proxy battle with activist hedge fund Casablanca Capital, the company's prospects are dim.

A short history of Cliffs
The past six months have been eventful for Cliffs. Essentially, two main factors have been the source of Cliffs' downfall, the falling price of coal and iron ore. As a relatively high cost producer, falling commodity prices have hit Cliffs harder than most.

Then Cliffs become embroiled in a proxy fight with Casablanca Capital, an activist hedge fund looking to instigate change at Cliffs and unlock value. The fund holds around 5% of Cliffs and is looking to change the management team, as well as split up the company. I have covered the proxy battle in greater detail here.

After Casablanca initiated its stake and made clear its demands, there were several heated exchanges between the fund and Cliffs. During this period there was also speculation that Cliffs might be in breach of its lending covenants.

Luckily, within the last few weeks, Cliffs' management has started to take action. Firstly, the company's capex budget was cut by $100 million per annum. Secondly, the company idled the Pinnacle met coal mine to reduce cash burn. And Thirdly, Cliffs has renegotiated its credit facility, securing greater financial flexibility.

Nevertheless, the company remains in a proxy battle with Casablanca. While Casablanca is looking to replace Cliffs' whole board of directors, Cliffs has issued a compromise, allowing Casablanca to put three candidates up for election. These candidates will be able to elect a new CEO, along with the rest of the board.

Still, even now after all the above, Cliffs is struggling; it would appear that things are only going to get worse for the company.

Getting worse
According to some sources, BHP Billiton (NYSE:BHP), the world's largest integrated miner is ramping up its iron ore production. There is really only one explanation for this, the company is trying to put high-cost producers out of business.

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For the first time in several years the global iron ore market is set to be oversupplied this year, as miners like BHP Billiton, Vale, and Rio Tinto ramp up low-cost output as prices fall. The price of iron ore fell to a two-year low of $89 per tonne during June.

According to BHP's president of marketing, there is "a significant overhang of low-cost supply coming to market in the face of a slow but steady increase in demand... it's really important for the high-cost suppliers to shut in a reasonably efficient manner..."

Cliffs is a high-cost producer, and this move by BHP is likely to put the flailing, mismanaged company in an extremely perilous position.

These are Cliffs' estimate production costs for 2014, according to the company's first-quarter earnings release:


US Iron Ore

Eastern Canadian Iron Ore

Asia Pacific Iron Ore

Cash cost per ton




DD&A per ton




Total cost per ton




Source: Cliffs' first quarter earnings release. Figures in $US. DD&A stands for depreciation, depletion and amortization. 

Based on information supplied by Bloomberg, from analysts at UBS AG. The average operating cost of iron ore production at China's mines is within the region of $80 to $90 a ton. Moreover, Rio's operating cost is in the region or $44 per ton, BHP's is $53 per ton and Vale, $68.

Based on these numbers then, it's easy to see how Cliffs could be quickly forced out of the market. 

Foolish summary
So all in all, around one third of Cliffs' shares are sold short but until the company's fortunes have drastically changed, the company's future looks gloomy. Additionally, with BHP Billiton aggressively pushing down the price of iron ore, Cliffs, as a relatively high-cost producer, will suffer.

Unfortunately, the future does not look bright for Cliffs.