Summary

• Cliffs is struggling with an unfavourable commodity pricing environment and the company should update cost cutting measures.
• The company’s asset sales are still to materialize.
• There’s concern about Cliffs’ debt facilities and the company’s potential default.

Cliffs Natural Resources Inc (NYSE:CLF ) reports its third quarter results after the close later today and there are several trends that investors need to look out for within the company results.

Asset sales

After successfully replacing much of Cliffs’ board, activist hedge fund, Casablanca Capital is now trying to break the company up.

Cliffs has made some progress in preparing its assets for sale over the past month. There’s talk that mining giant Glencore has been interested in the company’s Australian iron ore assets ; Glencore is looking to get into the iron ore industry, having no iron ore mines itself. Glencore is looking to take advantage of a weak pricing environment to buy assets at marked down prices. Further, the Australian assets, which have been valued at as much as $876 million have attracted interest from others, including Mineral Resources Ltd. and Mount Gibson Iron Ltd. No sale has materialized as of yet.

Cliffs has hired Jefferies Group LLC to advise on the sale of its Australian assets, while Deutsche Bank AG is working on the divestment of U.S. coal operations. So far, things seem to be going well. The company has not made any major sales yet, although an announcement could be made alongside results. Management has sold off the group’s stake in Canadian graphite mine developer Zenyatta Ventures Ltd. It has also decided to sell its majority holding in a Canadian nickel project part-owned by First Point Minerals Corp.

There’s also been a certain amount of progress at the company’s Bloom Lake mine, which has become somewhat of a money pit for the company. According to Cliffs’ Chief Executive Officer, Lourenco Goncalves the company is talking with four major players in the steel industry with the intention to sign these partners who will offtake all mine production and contribute to the cost the stage two development.

So, hopefully alongside today’s results, or on the following conference call, Cliffs’ management will shed some light on how asset sales and the development of Bloom is progressing.

Short-term Jump

Cliffs’ shares have rallied going into today’s results, a rally that appears to be driven by two factors. Firstly, is seems as if the market is betting that the company will be able to get a good price for rumored asset sales. Secondly, there seems to be somewhat of a short squeeze occurring, as with nearly 42% of the company’s issued share capital short, it won’t take much for a short squeeze to occur.

Today’s results should shed some light on whether or not Cliffs’ underlying business has changed, or if the company is still struggling. Certainly, from the outside there seems to have been change in the underlying fundamentals of the business, the iron ore price remains below $90 per ton and the price of coal also remains depressed. Actually, the only news that has been released by Cliffs’ management is the revelation that the company will take a $6 billion charge to write down the value of its seaborne iron ore and coal assets during the third quarter. With only $13.1 billion in assets and $7.1 billion in liabilities reported at the end of the second quarter, a $6 billion charge will reduce shareholder equity to zero.

After this writedown, it’s believed that Cliffs will be in breach of debt covenants. the company has stated that it has to maintain a debt-to-capital ratio of less than 45% for its lenders to be happy. With shareholder equity going to zero, the company is likely to have a hard time convincing lenders that it is a safe counterparty.

According to Citigroup:

The announcement on Friday of a covenant breach (max 45% debt to capitalization), post asset writedowns, could force the company to cut or eliminate their dividend as well as the stock buyback program. Management is trying to JV or sell their Canadian and Australian mines, but we estimate that both are posting negative free cash at the moment, pressuring potential transaction values

Anything to look forward to?

So, do shareholders have anything to look forward to ahead of the company’s results? Well, management will hopefully update the market on asset sales and strategy going forward. Additionally, there’s some talk that production for the quarter could be stronger than expected, and chatter suggests that Cliffs will benefit from cost cutting initiatives, which will see the company’s profit margins widen and the company reduce its cash loss.

Still, if it’s true, and Cliffs is in fact in breach of its loan covenants, then the company could be in real trouble going forward, unless asset sales are announced, or there’s a sudden change in the iron ore market, sending prices rapidly higher. One thing to note is that if the potential buyers for Cliffs’ assets know that the company is eager to sell, the company won’t be able to get a great price. Asset fire sales rarely end well for the seller.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.