-- We expect U.S.-based Cliffs Natural Resources Inc.'s operating performance and liquidity will be worse than we previously estimated due to lower-than-expected iron ore and metallurgical coal prices.
-- We are affirming our ratings on Cliffs, including the 'BBB-' corporate credit rating, and are revising our outlook to negative.
-- The negative rating outlook reflects our view that Cliffs' debt burden is high relative to its EBITDA and cash flow generation in the current price environment.
On Dec. 5, 2012, Standard & Poor's Ratings Services revised its outlook on Cleveland-based mining and natural resources company Cliffs Natural Resources Inc. to negative from stable. At the same time, we affirmed all of our ratings on Cliffs, including the 'BBB-' corporate credit rating.
The outlook revision reflects our view that 2012 and 2013 operating performance and liquidity will be worse than we previously expected, owing to lower-than-expected iron ore prices and metallurgical coal prices. In response, Cliffs recently announced significant changes to its 2013 operating plan, which included the delay the expansion of its Bloom Lake mine in Eastern Canada, as well as idling a portion of its U.S. iron ore production.
Our base case scenario uses the assumption that 2013 iron ore prices will remain around current levels of $120 per ton. As a result, we anticipate that Cliffs will generate 2012 and 2013 adjusted EBITDA of $1.4 billion and $1.2 billion, respectively, down from our previous estimates of $1.8 billion to $2 billion for each year. As a result, debt to EBITDA is likely to be between 3x and 3.5x in 2012 and 2013, compared with our previous estimate of 2x to 3x for both years. Our new estimates are weak for the current rating. Furthermore, we now believe Cliffs will burn cash in 2012, and cash flow generation in 2013 will be negligible.
The ratings on Cliffs reflect our view of the company's "satisfactory" business risk profile and "intermediate" financial risk profile. These assessments reflect the company's domestic market position in the North American iron ore market, high barriers to entry, and potential to generate significant cash flow throughout a cycle. However, our rating also incorporates the highly cyclical nature of the iron ore business (given exposure to the volatile steel industry), Cliffs' significant customer concentration, the company's relatively high cost structure, and the high capital expenditures associated with bringing its Eastern Canadian operations fully online.
Cliffs is the largest producer of iron ore pellets in North America, a major supplier of direct shipping lump and fines iron ore out of Australia and Canada, and a producer of metallurgical (met) coal. Based on the location of the company's reserves in North America, we consider Cliffs a high-cost producer of both iron ore and met coal relative to competitors. While we think Cliffs' Eastern Canadian operations will lower its overall cash costs once it is fully online, the delay in its expansion will cause costs to remain relatively high.
Cliffs is highly exposed to the cyclical steel industry, which we estimate accounts for more than 85% of revenue. As a result, operating results fluctuate with economic cycles, albeit to a lesser extent than other parts of the industry, given the contract-driven nature of the iron ore business. While the longer-term outlook for the worldwide steel industry remains relatively positive, given the expected increase in demand as emerging regions continue to develop, steel remains a commodity, and both iron ore and coal prices will fluctuate.
Given our expectation for reduced EBITDA, we believe the headroom on the 3.5x leverage covenant that governs Cliffs' credit facility will narrow, which has caused us to revise our assessment of Cliffs' liquidity to "adequate" from "strong." Our view of the company's liquidity profile incorporates the following expectations:
-- Liquidity sources (including balance sheet cash and availability under the company's $1.75 billion revolving credit facility) over the next 12 months will exceed uses by at least 1.2x.
-- Sources of cash would continue to exceed uses even if EBITDA were to decline by 15%.
-- The company would remain in compliance with financial maintenance covenants if EBITDA dropped 15%.
As of Sept. 30, 2012, Cliffs had total liquidity of about $1.5 billion, comprising $36 million of balance sheet cash and borrowing capacity of $1.4 billion on its $1.75 billion unsecured revolving credit facility due 2017.
Under our current price assumptions, we expect Cliffs to burn cash in 2012 and generate negligible cash flow in 2013, based on capital expenditures of $1 billion and $750 million, respectively. We estimate maintenance capital expenditures of about $300 million annually. In addition, we believe Cliffs will maintain its current annual dividend of about $300 million to $350 million annually, although we would expect Cliffs to rationalize its dividend policy if its cash burn accelerates.
Cliffs' credit facilities are governed by a 3.5x maximum leverage covenant and a 2.5x minimum interest coverage covenant. We believe headroom under these covenants will diminish as a result of the low price environment, and is one of the factors in the revision of our assessment of Cliffs' liquidity to "adequate" from "strong."
Cliffs' nearest maturity is 2013, when its $270 million of private placement notes mature. We expect that Cliffs will address the maturity in a timely manner.
The negative rating outlook reflects our view that Cliffs' debt burden is high relative to its EBITDA and cash flow generation in the current price environment. We could lower the rating if credit metrics remain above 3x for an extended period, cash burn accelerates, or if we reassess Cliffs' business risk to be "fair" as opposed to "satisfactory" because of adverse changes in the competitive environment (including sustained low commodity prices).
Conversely, we could revise the outlook to stable if iron ore prices increase, causing Cliffs to generate better-than-expected EBITDA and cash flow, or if Cliffs sells additional assets or reduces its dividend to preserve cash, which we would expect Cliffs to use to reduce its significant debt burden.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011.
-- Key Credit Factors: Methodology And Assumptions On Risks In the Metals Industry, June 22, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Temporary contact information: Megan Johnston (917-715-3892), Marie Shmaruk (61-3-9631-2040)
Ratings Affirmed; Outlook Negative
Cliffs Natural Resources Inc.
Corporate Credit Rating BBB-/Negative/-- BBB-/Stable/--
Senior Unsecured BBB-