Things have to go really, really wrong for shares of a company to plummet close to 43% when the broader market has made a positive 7% return on the year. In the case of Cliffs Natural Resources (NYSE:CLF), its free fall is a product of market conditions and management squabbles.
Is this the bottom for Cliffs? Or could things get worse? Let's take a look at what has sent shares of Cliffs through the floor and what the company may have in store to turn things around.
Killed by commodity prices
Two principal business segments of Cliffs -- iron ore and metallurgical coal -- are two of the worst commodities to be involved in today. Both have seen prices fall through the floor as Chinese steel demand has not been what it was a few years ago, and many of the mines designed to satisfy that formerly huge appetite are finally online. This massive oversupply is being felt across the entire iron and steel industry today. Spot prices for iron ore are at a dismal $85 per ton, less than half what it was a few years ago. Also, metallurgical coal prices internationally are also in the $110 per ton range. At these prices, many companies are selling for less than the cash cost to produce them.
This persistent price slide has taken Cliff's shares with it; not only is the company down this year by 43%, but anyone that has bought shares in the past five years has lost value as well.
Of course, the company didn't do itself any favors when it purchased Consolidated Thompson back in 2011 for $5 billion. Sure, iron ore prices at the time were closer to the much more lucrative price of about $175 per ton, but with prices where they are today the company is hemorrhaging money from its Canadian iron ore and North American coal segments. It has tried to stop the bleeding by idling its Wabush iron ore and Pinnacle coking coal mines, which have significantly reduced cash costs. Unfortunately, though, these production costs have not been able to keep pace with the even faster declining prices.
The one saving grace for the company is that it isn't in as dire financial straits as many other players in this space. With a debt to capital ratio of 31.7% and an EBITDA to interest expense ratio of 6.9 times, the company is doing well enough to keep its creditors off its back for a little while longer. The major issue it will need to address is the cash losses it is taking from continuing operations. Continuing operations have consumed $123 million in cash on top of the $148 million in capital expenditures. At this rate it will need to take on more debt or resort to other means to cover its cash shortfalls.
The times they are a changin'
The other thing that may make a few investors weary about investing in Cliffs today is that the company has been in a long battle with activist investor group Casablanca Capital. Somehow with just over 5% of the company's shares outstanding, Casablanca Capital has recently gained control of the board with six of the 11 director seats, as well as a hand-picked chairman and CEO at the helm in Lourenco Goncalves. With its new-found power, it is hoping to turn things around for Cliff's shares by making some major assets sales.
In the past month, the company has hired multiple investment banks to investigate the sale of its North American coal and its Asia Pacific iron ore businesses. There are no definite plans to sell these assets as of yet, but based on the demands of Casablanca and its heavy influence at the top of the company it's very likely to happen provided it can find someone to buy them at a somewhat reasonable price.
What a Fool believes
Things look really rough for Cliffs right now, and based on iron ore and metallurgical coal price forecasts it doesn't look like there is a whole lot of relief coming around the corner anytime soon. Investors who are extremely patient might see a value opportunity here -- shares do trade at only 40% of tangible book value and only 132% of current assets -- but with the activist investor group looking to make some huge sales at what will likely be a major discount to what they are worth on the balance sheet, the book value of the company may be slightly higher than its actual market value. So, yeah, there is a definite case for a deep value candidate, but it may take a very long time to realize it.
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