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What Could Make Moody’s Upgrade Cliffs Natural Resources Further?

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Sep. 29 2016, Updated 2:04 p.m. ET

Financial leverage

While it’s important to keep an eye on a company’s financial leverage, it’s increasingly important to do so in today’s volatile times. During its 2Q16 earnings call, Cliffs Natural Resources’ (CLF) management reiterated that in no uncertain terms, its number-one priority for proceeds from any source is to retire its debt.

Other US (VTI) steel companies with high financial leverages, including ArcelorMittal (MT), AK Steel (AKS), and United States Steel (X), are also making efforts to reduce their debts.

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Upgrade by Moody’s

Cliffs’s debt reduction efforts are probably working. On September 8, 2016, Moody’s Investor Service upgraded Cliffs from Ca to Caa1, most likely due to those efforts. It’s a two-notch upgrade. Moody’s outlook is stable for the company. It said, “The upgrade reflects the improving trends evidenced in Cliffs performance on strengthened fundamentals in the US steel industry, the dominant market for Cliffs iron ore pellets, and an improving order book as well as the successful renegotiation of the contracts with ArcelorMittal USA LLC, which had expiry dates of late 2016 and early 2017.”

Moody’s went on to add, “The new 10 year agreement, which expires in 2026, includes purchases of up to 10 million tons annually and a minimum of 7 million tons, as well as other volumes received has also resulted in the restart of the United Taconite mining facility and an increase in expected shipments for 2016. The upgrade also considers the company’s reduction in debt, both through the issuance of the 1.5 lien secured notes exchanged for senior unsecured and 2nd lien notes.”

More upside

Given the positive sentiment in the US steel market, Cliffs is expected to generate positive free cash flow. In line with the company’s priority of reducing debt, if all of this is applied to debt reduction, the company can certainly come out of its debt trap. This could lead to more upgrades by the rating agencies.

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