Casablanca Isn't the Only Problem for Cliffs Natural Resources

While Cliffs fights off Casablanca Capital, the company is bleeding cash from existing operations.

Rupert Hargreaves
Rupert Hargreaves
Jul 23, 2014 at 8:36AM
Energy, Materials, and Utilities

Embattled iron and coal miner, Cliff Natural Resources (NYSE:CLF) is stuck between a rock and a hard place.

On one hand, the miner is locked in an expensive and time-consuming proxy battle with Casablanca Capital, an activist hedge fund, which currently owns around 5% of Cliffs' shares. And on the other hand, Cliffs is struggling due to unfavorable iron ore pricing.

Poor decisions
As the price of iron ore has slumped over the past 12 months, Cliffs has felt the effects. However, the company, in some respects, only has itself to blame.

Indeed, Cliffs' investment strategy has hardly been conservative, and according to the company's biggest critic, Casablanca Capital, it has been estimated that the company has wasted $9 billion acquiring mining assets, some of which are yet to be brought into production. The biggest of these red herring projects is the Canadian Bloom Lake mine.

Cliffs spent $4.9 billion acquiring Bloom Lake and has since spent $1.5 billion bringing the mine into production. The second stage of Bloom Lake has been indefinitely suspended as the company looks to conserve cash, although it's questionable if the mine is at all viable.  

Bloom mistake
Unfortunately, the Bloom Lake mine is everything an iron ore mine shouldn't be; expensive, delayed and tied into crippling contracts.

During the first quarter Bloom Lake hit a record level of production 1.5 million tons. However, on the cost side of things, the first quarter cash cost was $94 per ton, including a $7 per ton lower-cost-or-market inventory adjustment. To put this into some perspective, the current price of iron ore is around $97 per ton and has fallen as low as $89 during the past six months.

Excluding this, Bloom Lake Mine's first-quarter 2014 cash cost was $87 per ton. This is compared to $89 per ton in the year-ago quarter. Cliffs was also forced to take a $16 million penalty during the quarter, incurred from a minimum tonnage rail shipment contract not being met, as a result of the delay in the Bloom Lake Phase II expansion.

All in all, with these high costs piling pressure on Cliffs, the company's operating loss per ton of iron ore produced from its Canadian operations during the first quarter was $31 during the first quarter.

Turning away
A high cost of production and limited financing has already stalled the Bloom Lake Phase II, but the life of the whole Bloom Lake project could also be in jeopardy.

However, for Cliffs, closing Bloom Lake will not be an easy task. Analysts believe that even a full shutdown of the project would incur costs of $275 million to $300 million per annum. Broken down, these costs are mainly due to take-or-pay agreements, as well as worker severance costs and ongoing costs related to the run-down of the mine.

No choice
Nevertheless, Cliffs may not have a choice in the matter. According to Wall Street, Cliffs' Canadian operations are losing around $60 million per annum, excluding interest, tax and depreciation costs. Further, the Street believes that Bloom Lake is burning through $260 million per annum in cash at current rates. Analysts are also stating that the recent idling of Pinnacle will cost the company $30 million to $40 million. That's a total cash burn of around $300 million per annum just from Bloom Lake and Pinnacle.

On the first quarter earnings conference call, Cliffs' management revealed that it was working with bankers to look at strategic operations for Bloom Lake. A sale may be the best option, although with costs being so high, the company might not be able to find a buyer.

Foolish summary
So overall, while Cliffs fights its battle with Casablanca, the company is bleeding cash. The Bloom Lake is a huge red herring. Now the second stage of the project has been suspended, it is unlikely that the project will be about the reach the levels of output needed to reduce costs significantly.

Cliffs' management may need to take drastic action in order to keep the company alive.