Cliffs Natural Resources: ‘Breach of Covenants Possible’ Despite Cost Cuts, RBC Says

After yesterday’s close, Cliffs Natural Resources (CLF) said that it would cut capital spending by $100 million in 2014, its remedy for continued weakness in iron and coal.

Wells Fargo’s Sam Dubinsky says Cliffs’ management is “doing the best it can” but that “pain is inevitable.” He explains why:

While we think the new CEO is doing a commendable job tightening operations, we see no easy way out for CLF shares due to negative long-term fundamentals for iron ore and ongoing cost challenges in Canada. Note we estimate Cliff’s recurring EBITDA at ~$500M at today’s iron ore pricing, below current Street estimates near $880-$890M for 2014/2015, though the cap-ex cut should keep free cash flow near break-even.

Agence France-Presse/Getty Images

RBC Capital Markets’ Fraser Phillips and team thinks Cliffs Natural Resources could breach its debt covenants:

Cliffs’ reduction of its capital expenditure will help it to conserve cash during the current weak iron ore pricing environment. While we view the capital outlay reduction as a positive, Cliffs’ debt covenant holiday is over, and a breach of covenants is possible if the current weak iron ore price environment persists.

Cliffs must maintain a total funded debt/EBITDA ratio less than 3.5 and an EBITDA to interest expense ratio for the trailing four quarters of at least 2.5. At the end of Q1/14, we calculate that Cliffs’ debt/EBITDA ratio was 2.5 and EBITDA/interest was 7.5, and we expect Cliffs to end the year with debt/EBITDA of 3.1 and EBITDA/interest of 6.5. However, our current iron ore price forecast for 2014 is $119.25/tonne CFR China. Our analysis indicates that if the average spot price for 2014 is $114.30/tonne CFR China or below, Cliffs will trigger its total funded debt/ EBITDA covenant. This corresponds to a spot price for the remainder of the year of $110.25/tonne or below.

Shares of Cliffs Natural Resources have slid 3.9% to $15.73 at 11:13 a.m., while other iron miners have gotten hits as well. Rio Tinto (RIO) has dropped 2.8% to $53.04, BHP Billiton (BHP) has fallen 1.3% to $69.18 and Vale (VALE) is off 0.7% at $12.98.