Cliffs Natural Resources (NYSE:CLF), the Cleveland-based iron ore and metallurgical coal producer, has been one of the worst performing US equities over the past couple of years. Shares are down about 40% year to date and have fallen nearly 70% over the past two years, as investors have become increasingly concerned about the negative outlook for iron ore, which accounts for roughly 85% of Cliffs' revenues.
As the company prepares for its annual shareholder meeting on July 29, which will determine whether or not management retains control of the board, there have been a couple of encouraging developments – huge spending cuts and more favorable credit terms. But will they be enough to halt Cliffs' decline?
Massive cost cuts
The first major encouraging development is that Cliffs is serious about slashing costs to preserve cash during a period of weak seaborne iron ore and metallurgical coal prices. The company has pledged to slash its 2014 capital spending by more than 60% year over year to a range of $275 million-$325 million, which amounts to roughly $650 million in cost and capital reductions this year versus last year.
As part of this spending reduction strategy, Cliffs said it will indefinitely suspend an expansion at its high-cost Bloom Lake mine in Quebec and shut its loss-making Wabush mine in the Province of Labrador-Newfoundland. It has also decided to idle its Pinnacle metallurgical coal mine in West Virginia.
These measures should help reduce the company's cash burn since Cliffs Canadian operations are its least profitable. With an iron ore price of $90 per ton, the company's Eastern Canadian operations generate a $60 million EBITDA loss and negative free cash flow of $260 million, according to Nomura analysts.
The idling of the Pinnacle mine should help as well since Cliffs' North American coal segment is also unprofitable, having reported an operating loss of $1.99 per ton last year due to lower coal prices. Though the Pinnacle mine isn't particularly high cost, idling it should also help reduce Cliff's exposure to the seaborne iron ore market, which features greater pricing volatility than the domestic market.
Amendment of credit terms
Another encouraging sign for Cliffs is the recently announced amendment to the credit terms for its $1.75 billion revolving credit facility. The previous terms required the company to maintain a total funded debt-to-EBITDA ratio of less than 3.5x and an EBITDA to interest expense ratio for the trailing four quarters of at least 2.5x.
As of the end of the first quarter, Cliffs had no problem complying with these covenants, with a debt-to-EBITDA ratio of 2.5x and an EBITDA to interest ratio of 7.5x. But if iron ore prices were to remain below $100 a ton for the rest of the year, it is highly likely the company would have violated its total funded debt-to-EBITDA covenant.
Luckily, Cliffs' creditors have replaced the previous leverage covenant ratio with a new covenant that requires the company to maintain a debt-to-capitalization ratio of under 45%, as well as raised its minimum acceptable EBITDA-to-interest expense ratio to 3.5x.
These more favorable terms should ensure the company has access to its credit facility during a challenging commodity price environment. As of the end of the first quarter, Cliffs' had liquidity of $1.9 billion, including $364 million in cash and equivalents, a 32% year-over-year improvement.
Will it make a difference?
Cliffs' decision to dramatically slash capital spending and idle high-cost operations should help the company preserve cash during a period of lower iron ore and coal prices, while its newly amended credit terms should ensure it doesn't lose access to its most reliable source of liquidity. Together, these measures greatly reduce the likelihood of bankruptcy in the near term.
Unfortunately, Cliffs' future will be decided overwhelmingly by the price of iron ore, which is, in turn, largely determined by a combination of Chinese steel demand and global supply. Unless iron ore prices return to a level above $110 a ton, or Cliffs finds a buyer for its high-cost Canadian operations, it's difficult to envision a bright future for the company.