While it is important to keep an eye on a company’s financial leverage, it becomes increasingly important to do so in an industry downturn such as now. High levels of debt can put a strain on company’s cash balances in the form of interest expenses. It also impacts company’s expansion and other plans negatively.
Freeport-McMoRan (FCX), Teck Resources (TCK), and Vale SA (VALE) are among those commodity companies that are grappling with a huge debt pile. In this part of our series, we’ll discuss Cliffs Natural Resources’ (CLF) financial leverage.
Stretched balance sheet
Cliffs Natural Resources ended 4Q15 with net debt of $2.4 billion as compared to $2.5 billion at the end of 3Q15. On January 27, 2016, the company announced the debt exchange offer. This entails offering bondholders new secured notes in exchange for their current holdings.
This should help the company reduce its debt and interest expenses. However, it might not be enough to move the needle on company’s high financial leverage. The company’s operational cash generation will need to be substantial to have any meaningful impact on its debt position.
More trouble ahead?
It has net debt-to-forward EBITDA (earnings before interest, tax, depreciation, and amortization) ratio of 10.5x, which is very high in a depressed commodity price environment. Going forward, company’s EBITDA is expected to deteriorate at a faster rate as price declines outpace cost reductions. In the absence of significant debt reduction, this should further increase company’s net debt to EBITDA ratio.
In the current commodity price environment, CLF’s cash generation doesn’t seem to be enough to make a dent in its debt. The company needs higher iron ore prices to reach any significant level of FCF.
Other companies with high financial leverage, including ArcelorMittal (MT), AK Steel Holding Company (AKS), and U.S. Steel Corporation (X), could be under pressure in 2016. Investors looking to diversify the risk of investing in a single security can consider the SPDR S&P Global Natural Resources ETF (GNR). Almost 25% of GNR’s holdings are invested in steel and other metals companies. Nucor Corporation (NUE) forms 1.7% of GNR’s portfolio.