Analyst Outlines Why Cliffs May Be Worth Only $1

Previously, Credit Suisse was bullish in the near-term as analyst Nathan Littlewood detailed in his October report regarding the company’s earnings, but he went on to say the analyst firm was more cautious on the long term. In fact, Credit Suisse’s call was still an Underperform rating at that time.

However in his most recent report, Littlewood was not as optimistic:

But some handicaps are just too great: Despite the progress being made, we believe Cliffs’ balance sheet handicap is simply too great. Cliffs’ $2.8bn net debt position (implying CSe CY15 ND/EBITDA of 8.9x) is a function of a failed empirebuilding attempt by prior management. Near term earnings potential is insufficient to support the company’s current level of indebtedness. The US steel industry needs most of Cliffs’ iron ore output, but these assets are not capable of sufficient mid-cycle earnings generation to support the balance sheet. At some point within the next 1-2 years, we believe this business needs to be recapitalized, and we accordingly reduce our target price to $1 (from $10).

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When you hear the term “recapitalization” this is almost never good for existing shareholders who are in ahead of that recapitalization. It does not assure that the value is zero of course, but such corporate actions either wipe existing shareholders out or heavily dilute them in order to keep the company alive.

There are different levels of survival, but what will be indicative of Cliffs’ position is what the company reports as its guidance for 2015 and how the market will adjust its estimates.

According to Credit Suisse, the outlook past this point is uncertain to say the least:

No long-term valuation support: Whilst we continue to believe that there exists potential for positive progress on strategic initiatives, as we focus on 2015 and beyond and update ests to reflect recent commodity price updates, Cliffs’ lack of longer term valuation support is startling. Our target price falls to $1 (from $10) rating remains Underperform, and we reduce our 2015 and 2016 EPS estimates to ($0.26) and ($0.19) from $0.49 and $0.41, respectively.

Looking at the short interest of Cliffs, it would appear investors have been equally bearish, as the past five settlement dates have recorded the highest readings in the past 52-weeks.

Hopefully for Cliffs, this does not turn into another “I told you so” moment like when the company was pursuing options to back out of Bloom Lake.

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Shares of Cliffs were down over 8% at $6.09, following the Credit Suisse report and in the first two hours of trading Wednesday. Earlier in the morning, shares hit an adjusted low not seen since 2004. Its current 52-week range is $5.63 to $27.13. The stock has a consensus analyst price target of $8.18.