These Stocks Appear to Be Sliding off the Cliff

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Cliffs Natural Resources recently announced it would slash another $100 million from its 2014 capital spending plan. That's a 25% reduction to a plan that was already cut by 55% from 2013 spending levels. It's just another piece of worrisome news for a mining company that appears to be sliding off the cliff (no pun intended) and taking its investors with it.

Bad news keeps getting worse
Cliffs Natural Resources continues to cut spending in an effort to keep its debt under control. The problem is that the markets for iron ore and metallurgical coal are deteriorating faster than the company can reduce spending. In fact, according to one Wall Street analyst, Cliffs might breach its debt covenants later this year.

The big issue for Cliffs right now, as pointed out in Barron's, is the price of iron ore in China. A dip in the average spot price of iron ore from the current forecast of $119.25 per ton to under $114.30 per ton would trigger a breach of Cliffs Natural Resources' total funded debt-to-EBITDA covenant, according to the analyst quoted in the article. Given that no one knows how long weak iron-ore prices will last, nor how far prices might fall, this remains a worrisome possibility for Cliffs investors.

Metallurgical coal is suffering, too
Cliffs Natural Resources is being hit by a one-two punch, as the price of both of its key steelmaking materials are weak. This has also pushed pure-play metallurgical coal producer Walter Energy  off a cliff of its own this year. As the following chart shows, both stocks are struggling to find a bottom:

CLF Chart

CLF data by YCharts.

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Walter Energy is burning through cash. The company has $430 million in cash, which is just enough to last it through the end of next year. This is one reason why its debt is trading at a distressed level of just $0.60 on the dollar. While bankruptcy isn't imminent, Walter Energy certainly is teetering on the brink.

This is why more than half of Walter Energy shares have been sold short by investors. As of the end of last month, a staggering 57.3% or 35.67 million, shares were sold short (with the total number increasing by 1 million shares from the end of March to the end of April). Meanwhile, investors are only slightly less bearish on Cliffs Natural Resources, with 37.3%, or 50.66 million, of shares sold short as of the end of April. Needless to say, investors think both of these stocks are going to keep sliding.

Investor takeaway
While the prices for iron ore and metallurgical coal could turn around, there's just as much likelihood that the turn won't come. That's why investors need to be very careful when thinking about being a contrarian here. Sure, the markets could turn and that bet could pay off, but right now it's a coin toss; it would be gambling, not investing. That is a really quick way to burn a hole in any portfolio. 

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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