Cliffs Natural Resources: What Else Could Go Wrong?

It’s been a bad day for iron miners like iron miners like BHP Billiton (BHP), Rio Tinto (RIO) and Vale (VALE) after Morgan Stanley cut its iron-ore price estimates. For Cliffs Natural Resources (CLF), the damage could be even worse.

Reuters

Morgan Stanley’s Evan Kurtz and team explain why they think Cliffs Natural resources’ dividend is imperiled by lower iron-ore prices:

Morgan Stanley's commodity team is lowering its iron price deck (2014 estimate falling to $105/t from $118/t and 2015 estimate declining to $90/t from $114/t)…Given weak pricing, we believe Cliffs could violate its credit facility's max Funded Debt to EBITDA covenant. We forecast Funded Debt to EBITDA rising to ~4.0x by year-end 2014 vs. the permitted maximum of 3.5x. Without a renegotiation of terms, we think Cliffs could potentially be precluded from accessing its credit facility…

Given reduced cash flow generation and the possibility of a covenant violation, we believe the dividend may be at risk of being cut, particularly if the company acts to defend its credit rating. The common dividend requires ~$92m annually, rising to $108m after the preferred shares convert in 2016. We believe the company may be close to FCF breakeven before dividend payments beginning in 2015.

In a letter to shareholders, Casablanca Capital explained why they think much of Cliffs Natural Resources’ board has to go.

Since we began our campaign to create value for all of Cliffs' shareholders late last year, we have consistently emphasized that the Company is substantially undervalued as a result of strategic missteps, blatant mismanagement and a misalignment of incentives between Cliffs' shareholders and its Board of Directors and management…

A majority of the current Board and nine-member slate of Directors up for reelection approved both the $4.9 billion Consolidated Thompson transaction to acquire the Bloom Lake project and the subsequent $1.5 billion in capital expenditures. These ill-conceived investments were part of a broader diversification strategy that included the Coal, Chromite, Wabush and Amapá projects for a total outlay of $9 billion. None of these projects currently contributes one cent to earnings…

Shares of Cliffs Natural Resources have dropped 3.7% to $13.85 at 12:53 p.m., while BHP Billiton has fallen 1.3% to $66.86, Rio Tinto has declined 3.3% to $51.34 and Vale is off 3.7% to $12.71.

Barron’s Teresa Rivas offered her bearish take on Cliffs Natural Resources on May 30.

UPDATE: Cliffs Natural Resources has responded to Casablanca Capital:

The Company's Board and new management team led by Gary Halverson have taken – and will continue to take – decisive steps to reduce costs and prudently allocate capital while steadily improving Cliffs' financial and operating performance, including through the ongoing, comprehensive review of our portfolio of assets and strategic options. This Board and management team is best positioned to deal with the difficult price environment Cliffs is dealing with today. Change is already underway at Cliffs and we remain committed to enhancing value for all of our shareholders. Based on discussions with various shareholders, the Board of Directors is nominating a slate of nine directors for its eleven-person Board. As a result, we believe that at least two of Casablanca's proposed nominees will be elected to the Cliffs Board, so shareholders should vote using the Company's WHITE proxy card.