Cleveland Cliffs Inc (CLF)

[dndodd]

Here is a pretty fare article considering the source is SA.

Cliffs Natural Resources: The Turnaround Isn't Happening
Jan. 14, 2016 11:18 AM ET|45 comments | About: Cliffs Natural Resources Inc. (CLF)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary

Cliffs continues to be a turbulent and beleaguered equity that only the most risk-hungry investors should attempt to trade.

Cliffs needs to cut debt, but is stifled by the declining revenue from the domestic steel industry.

Getting rid of their remaining coal assets was a smart decision given the way that commodity has faired as of late.

Cliffs Natural Resources (NYSE:CLF) is a textbook "do not own" equity. It's been one of the worst investments of the last five years and is nearly finished. In fact, it's arguably just a few bad sessions away from the words "Chapter 11" cluttering headlines. Yet, with every equity, there's a way to squeeze out a profit and in devising a way to do so with CLF requires a full understanding of short-term catalysts for iron ore and the domestic steel industry. While the cost basis of owning CLF is undoubtedly cheaper today than it ever has been, the fact remains that the operating environment continues to face strong headwinds.

(click to enlarge)

Source

Steel, Iron Ore Continue To Struggle

Across the board, commodities companies are waiting for China to enact supply-side reform. They're also waiting for their competitors to curtail supply and cut capex further in an attempt to rebalance global prices. So far, the efficacy of both of approaches has been minimal. Since the bottom has not occurred yet, downgrades and credit troubles continue for stocks like Cliffs. Macquarie downgraded Cliffs last Friday, placing a weak, weak price target of $1.60, down from $6.00.

To try and take matters into their own hands, Cliffs has now exited from the coal business, now selling off Oak Grove and Pinnacle for $268 million total. Additionally, there is the potential for Cliffs to earn $50 million through 2020 on a revenue share, however this is contingent on several factors not yet disclosed. While this will help to provide a boost to earnings on the upcoming Q4 report, it's too little, too late considering their coal assets are being sold at the near bottom of the market.

Just Survive

On top of the company cutting capex and production, it needs to start focusing more on reducing the debt burden, as well as shifting to electronic arc furnaces (EAFs) away from blast furnaces as they are just too expensive. While the company is certainly not in a position to start cutting debt in a meaningful way, we come to the quick conclusion that they are really at the mercy of their operating environment. That's bad news considering the data we keep receiving about the domestic steel industry. Domestic steel production fell 8% last year.

While the U.S. Department of Commerce ruled that there would now be tariffs on imports of nearly 256% from China, as well as tariffs to offset the government subsidies from other countries, we haven't seen a pull back in foreign exports. If anything, we're seeing an increase, especially on the back of a stronger dollar. China has to counter the weak demand for steel in their country by exporting to the U.S., for which those exports increased 11% in December. So, even with the new tariffs, we're seeing increased foreign exports. Now, this begins to affect Cliffs in the sense that 79% of their revenue is derived from U.S. iron ore, and if they can't directly supply their customers U.S. Steel (NYSE:X), AK Steel (NYSE:AKS), and ArcelorMittal (NYSE:MT), then long-term contracts - due for renewal later this year - are going to be dictated at much lower prices, further hindering LT revenue. These contracts are the alpha and omega for Cliffs.

Meanwhile, you have the largest global iron producers BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) protecting market share by not cutting production, further sending the price of iron ore down. Both of these players have a far more stable financial standing than Cliffs and can easily outlast the company should prices further deteriorate.

Thus, the bankruptcy risk is all too real and I know we can't just throw that word around lightly, but there's really very little alternative if the operating environment continues to suffer. Cliffs has just $270.2 million in cash assets, but $2.71 billion in LT debt. Even so, they don't have any maturities until the 2018 3.95% notes, but the fact of the matter remains that they are overleveraged and the quarterly interest expense is now up to $61.7 million, which is cutting into they already thin quarterly revenues. Q3 showed $580.5 million in revenue.

Fortunately, it's not all doom and gloom. Some positive developments that I believe could occur in 2016 are the Essar plant in Minnesota, and the potential asset sale of Koolyanobbing in Australia, an iron ore mine for which they have a 100% interest. They've listed that Koolyanobbing has approximately $210 million worth of assets, for which that amount could considerably help CLF increase its financial standing and help get it through what could potentially be another year of low iron ore prices as we wait for China to push supply-side reform. Then again, they'd be selling assets at the bottom of the market.

(click to enlarge)Source: CME Group

Trading Massive Volatility

With the company in and out of oversold territory according to the RSI over these last few sessions, the stock has the technical basis it needs to breakout. It's well below its 50 and 200 DMA and has seen an aggravated decline in 2016 already. We saw a considerable amount of tax loss selling on CLF during December as the stock started around $2.25 and ended the year just above $1.60. We should reasonably expect further equity dilution in 2016, especially after hearing the change in the conversion rate for the preferred stock, for which they have to issue 1.26 million shares. The $200 million share buyback has now ended, so I don't believe we can expect management to prop up the equity at any point this year.

(click to enlarge)

Source: StockCharts

The primary problem with the "turnaround" argument with CLF is that it is based on the improved risk/reward scenario that we see after a large dip. Yes, this undoubtedly creates a lower cost basis, but with CLF seeing a multi-year decline, this argument has failed to show viability. Rather, I'd say the primary reason behind going long in CLF is to make a speculative acquisition play, whereby they get bought out in 2016 by one of the larger iron ore producers.

With the short interest now at 42.04% and days to cover at 14.6, we know one thing for sure - that if there's a rally in iron ore, then there's going to be a very aggravated increase in CLF based upon the amount of short covering. Now, of course, I believe it's fair to state that my pessimism is "late to the party," but how do we get into solution mode with CLF? Given the operating risks and management's actions with the equity, I doubt a play on either side of the stock is the answer. I wouldn't try shorting this company given the high cost of borrowing as well as the squeeze potential; however, I'm not going to go long until I see meaningful data on reduced Chinese exports and some signs of the tariffs working. Really, all that is left to go long in the bonds and be first in line if and when the company liquidates.

Conclusion

It's unfortunate to see a company like Cliffs trade so low. The company is set to report earnings on January 27, which is just two weeks away and I'm not at all optimistic. Cliffs is the largest supplier of iron ore to the North American steel industry, but need helps from its outside environment before we can start seeing a pickup in the share price.

http://seekingalpha.com/article/3810336-cliffs-natural-resources-the-turnaround-isnt-happening