seekingalpha.com
By: Winning Strategies
September 23, 2014

Is Cliffs Natural Resources A Good Buy?

Summary

• Currently, the metals and minerals industry is facing strong headwinds.
• Cliffs Natural Resources continues to struggle in the front of pricing pressure.
• The sum of all this is that Cliffs can lose its dividend sustainability thus making it a poor stock to buy over peers.

The metals and minerals industry has been going through hard times over the past few years due to the significant fall of commodity prices. This has happened on the back of the supply and demand dynamic and other economic factors. Prices have been falling due to the excessive domestic production in countries like China, India and others. This situation adversely impacted the largest and multinational producers like Vale SA (NYSE:VALE), BHP Billiton (NYSE:BHP), Cliffs Natural Resources (NYSE:CLF) and Rio Tinto (NYSE:RIO). Over the past twelve months, the prices of coal, potash, iron ore and copper reached its lowest level. According to Morgan Stanley, iron ore prices may again rebound to around $90/ton by the end of this year on the back of declining domestic production in China. This news may give some support to the iron ore prices and big producers in the coming days.

However, the adverse pricing situation has already impacted most of the companies operating in the metal and minerals industry. The situation has forced these companies to change their business strategies to counter the impact of pricing pressure. They stopped working on their growth strategies and started to invest in only high value, high growth assets while shrinking off non-core assets to give a support to cash flows and its balance sheet. In addition to that, they are expanding their productions from the existing assets through higher operational efficiencies. Mainly, lowering direct and indirect costs always remain their core objective.

Cliffs Natural Resources is one of the companies that have been hit hard by the volatility in the metals and minerals industry. Furthermore, the company added to this volatility by having differences among its top position-holders. Cumulatively, this led to a massive drop in the company's share price from $74 per share to, presently, $14 per share - a huge decline in the last three years alone. Cliffs Natural Resources has been losing value, sales, earnings, cash and dividends. This is mostly due to the company's strategy in front of strong headwinds and pricing pressure on its product line. Recently, Cliffs announced its first quarterly results which showed a massive decline in its sales and earnings. In addition to that, the cash flows also turned negative, the sales decreased by 26%, the consolidated margin went down by 66% and earnings came at a negative $2M. The second quarter loss was as a result of decreased market pricing on metallurgical coal and iron ore.

I believe this huge loss is the result of slow response from Cliffs in front of headwinds. Finally, Cliffs changed its expansion strategy and has looked to liquidate its non-core assets. Cliffs plans to save costs as much as it can and to reduce its capital investment. The company has reduced its capital investments to only $61 million in the recent quarter as compared to $271 million in the past year quarter. However, the company seems to be slow in its response. As a result of all this, a major stakeholder, Casablanca, has raised concerns about the company's strategy and management. Amidst all this, Cliffs still has to face strong pricing pressures on iron ore and coal. Two big banks recently said that Cliffs may lose its dividend stability in the coming days and I am of the same opinion. Due to the consistent fall in earnings, its cash flows turned negative and are not providing cover to capital investments and dividends.

Where Do the Other Players Stand?

In contrast, Vale SA has adopted the right strategy at the right time. The company has expanded its production at a significant level to offset the pricing pressure. In addition, Vale has a diversified portfolio as compared to Cliffs. Also, Vale has significantly increased its iron ore, phosphate, pallet, and coal production. In the recent quarter, the company has posted record iron ore production of 79.4 Mt. Vale has been also successfully lowering costs in order to maintain a balance between margins and operational costs. The company is also lowering capital investments and is only intending to invest in high growth, high value assets. It is also selling non-core assets to raise cash along with enhancing its operational efficiencies. In the past year alone, Vale has sold $6B of assets. In this year, it has sold its stake in the logistics unit, VLI, and its 22% stake in Norsk Hydro. All this has enhanced its cash potential which has allowed it to lower debt and look for growth opportunities while sustaining dividends. At the moment, its cash flows are enough to cover its capital requirements and dividend payments.

While Rio Tinto remains among the companies which have been strongly combating this situation, the company has adopted a similar strategy as Vale did, but it remains more efficient in implementing that to its business. It has been massively expanding its production and lowering its cost which is resulting in a gigantic increase in earnings. In the latest quarter, it has generated record levels of copper, aluminum and iron ore in production. Moreover, it has achieved its target of lowering costs of $3M this year in the first six months alone. All this resulted in a massive 21% growth in earnings. Furthermore, the company is in a very sound cash position because it has lowered its debt by $1.7M in the past six months and its free cash flows are adequately covering its dividends.

Final Notes

The metals and minerals industry has been experiencing headwinds and I am not expecting any sudden change in the business environment. However, some stabilization in the iron ore prices is expected late in this year on the back of China's production. I do not recommend Cliffs Natural Resources for defensive investors because the company is expected to post more losses in the coming days due to their late response to the economic environment. In contrast to that, Vale and Rio are in a good shape with their successful implementation on their business strategies.


seekingalpha.com
By: Winning Strategies
September 23, 2014