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Cliffs Stock: What Could Be the Next Positive Catalyst?

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Jun. 17 2016, Updated 9:04 a.m. ET

Financial leverage

While it’s always important to keep an eye on a company’s financial leverage, it’s becoming increasingly important to do so in today’s volatile times. High debt can strain a company’s cash balance through interest expenses and affect expansion plans.

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Buying discounted debt

Cliffs Natural Resources (CLF) has been consistently buying its discounted bonds from the Market to reduce its financial leverage. On May 24, 2016, Cliffs announced that it received a one-time $31 million payment from Minnesota Power as part of an agreement to enter into a long-term power contract. The company could use this cash to pay down debt.

Cliffs ended up 1Q16 with a net debt of $2.4 billion. That translates to a very high net debt to forward EBITDA (earnings before interest, tax, depreciation, and amortization) ratio of 9x.

Issuing equity to retire debt

While equity dilution could be a short-term negative to the stock, issuing equity to replace some debt could be in the best interest of the company’s long-term future. Seaborne iron ore prices have a downside remaining due to incoming supply and constant to declining demand. This could pressure its Asia Pacific division directly and US division indirectly.

Lower debt will help the company navigate better through this kind of downturn. In Cliffs’s 1Q16 earnings call, referring to issuing equity to reduce debt, management said that while the company takes share dilution very seriously, it will “consider all tools” in its toolbox. Issuing equity following months of share price strength could be a positive catalyst for the company’s stock price.

Other companies with high financial leverage, including ArcelorMittal (MT), AK Steel (AKS), and United States Steel (X), could be under pressure in 2016.

Investors looking to diversify the risk of investing in a single company could consider the SPDR S&P Global Natural Resources ETF (GNR). Almost 25% of GNR’s holdings are invested in steel and other metal companies. Nucor (NUE) forms 1.7% of GNR’s portfolio.

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