Why Cliffs Could Go Even Lower — Much Lower

We have seen analyst reports from Bank of America Merrill Lynch, Credit Suisse and Wells Fargo, all of which are far worse on the stock than just raising a caution.

Credit Suisse remains concerned on the outlook for Cliffs and the firm has yet to see anything that would make it get more constructive. As a result, Credit Suisse is raising its earnings per share (EPS) estimates to:

• 2015: -$0.11 from -$0.31
• 2016: -$0.08 from -$0.30
• 2017: $0.30 from $0.17

Cliff’s management has made some progress on a number of fronts, including cutting the dividend, closing Eastern Canada and monetizing coal assets. Despite continued and expected progress in this area, a lot of low-hanging fruit is now gone and progress toward a business turnaround from this point would be more challenging.

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The guidance implies no free cash flow in 2015. The brokerage firm went on to say:

We expect the combination of Cliff’s 2015 guidance and analyst mark-to-markets to see calendar year 2015 Consensus EBITDA settle in the $350-400 million range based on an IODEX assumption of $70-75/t (CSe $73/t). From here, deriving a free cash flow estimate requires the removal of Exploration ($5 million), capex ($125-150 million), and Interest costs ($170-175 million) – taking implied 2015 free cash flow to $0-100 million. Using spot ($63/t) iron ore, this falls to a negative number. With access to liquidity shrinking (the revolver was recently downsized) and Cliff’s cost of capital rising, the outlook remains challenging. We believe this business requires some form of restructure or recapitalization in the next 1-3 years.

Credit Suisse has an Underperform rating with a price target of $1.

Wells Fargo’s take on Cliffs is that investors have yet to flow through 2015 pricing and cost guidance. Cliffs may have reported an EPS beat on estimates for the fourth quarter, but it implies a boat-load of adjustments that may or may not apply to street estimates. Wells Fargo also considers the guidance to be below street estimates.

At its current levels, Wells Fargo estimates that Cliff’s shares trade near a multiple of 10 times 2015 EBITDA, which is a high multiple considering the weak balance sheet, risk from the ArcelorMittal contract reset and potential cash burn. Wells Fargo actually came out and said that it would, in fact, short the pop.

Merrill Lynch saw its fourth-quarter EPS estimate topped, but the company’s EPS included many adjustments related to the exiting of Canada. Falling iron ore prices highlight risks to Cliff’s earnings and cash flows. The firm ultimately rates Cliffs at Underperform with a $4 price target.

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Merrill Lynch said in its report:

While estimates can improve assuming Canadian ops can be restructured, falling global iron ore prices remain a challenge for earnings and cash flows. Guidance of selling prices and costs were below our expectations, but we could arrive at $129 million free cash flow or $0.40 per share using its guidance. Our $4 per share price objective was derived using 7.5-8x 2015-16E EV/EBITDA.

Shares of Cliffs were down 6% at $6.58 in the second half of Tuesday’s trading day. The stock has a consensus analyst price target of $6.68 and a 52-week trading range of $5.63 to $23.53