With the iron ore market as brutal as it has been in the past year or so, it's not that surprising that Cliffs Natural Resources (CLF +7.37%) has struggled. Even though money has been tight these past several quarters, the fact of the matter is that mining is a capital-intensive business that requires reinvestment in new equipment. So is Cliffs spending enough money to maintain its position as the dominant US producer of Iron ore? Let's take a look at Cliffs spending habits recently and see whether the business has enough money behind it to stay afloat in this down market
A different approach to investment: adjusted net capital expenditures
When most of us think of a business reinvesting back in the business, the first number we look at is capital expenditures. While this is a pretty good gauge of how the business is spending its money, it doesn't necessarily indicate whether the company is investing in growth or if it's just doing enough to keep the ship sailing on course.
A more accurate way to look at a how a company is investing in the business is to look at the company's adjusted net capital expenditures. This metric looks at how much a company is spending not just in capital expenditures, but also in research and development to determine how much is being reinvested in the business. On top of that, it also looks at how much money is needed to keep the business at its current state by subtracting out depreciation and amortization, which is a stand in for the decrease in value for its previous investments. If adjusted net capital expenditures is positive, it means the company is looking to grow, while a negative number means that the company could be at risk of shrinking.
Is Cliffs doling out enough capital?
The mining of iron ore and metallurgical coal isn't exactly an activity that requires lots of money for research and development. What it does need, though, is lots of capital spending on equipment that wears down over time. Also, when it comes time to open a new mine, capital costs can be very large and can take many years. With this in mind, it's not really shocking that Cliffs hasn't spent a dollar on research and development in the past five years, but it still has spent a lot of money on other things. Based on the financials of Cliffs, compiled by S&P Capital IQ, the company's adjusted net capital expenditures have looked like this since 2009:
Source: S&P Capital IQ, authors calcualtions
Two things really jump off the page here with these numbers. The first is all the money it spent in 2010 and 2011 on acquisitions. This is the money that went to the $5 billion purchase of Consolidated Thompson's mines in Canada, and part of the higher capital expenditures in 2012 and 2013 is the money that it spent to bring on the Bloom Lake mine, which was part of that acquisition.
That mine, and the high costs it has taken to bring it online, account for part of the reason that the company has been struggling as of late. The price of iron ore has been so weak that it cannot economically produce from these Canadian mines as well as in Australian and North American metallurgical coal. This is also why we have seen net capital spending in 2013 and so far in 2014 head so far south so quickly. With uneconomical mines, the company is idling many of its operations in hopes of better days ahead.
What a Fool Believes
The fact that the company has spent so little this year is a good thing. With the market for iron ore as poor as it is, the company needs to horde as much cash as it can to pay its debt obligations as well as hopefully have enough left over to at least keep its dividend payment to its investors going. The problem is that this cannot last. Eventually the company will need to start reinvesting in the business again. Hopefully by then the economics for iron ore will have improved enough by then that the company can afford to do so.
