Cliffs to take major hit in Q4

Two years ago when Cliffs Natural Resources (CLF-N) acquired Consolidated Thompson Iron Mines for US$4.97 billion, many critics argued the Cleveland-based company had overpaid.

Today Cliffs announced that it will take a US$1.4 billion goodwill impairment charge related to the Jan. 2011 acquisition due to the Bloom Lake mine’s lower long-term volumes and higher capital and spending costs, as well as a previously announced delay of its Phase II expansion. The impairment will be recorded as a non-cash expense for the year ended Dec. 31, 2012.

In addition, Cliffs told shareholders that it expects to take a US$100-150 million impairment charge related to its iron ore business in Eastern Canada; a non-cash pre-tax impairment expense of US$365 million on the recent sale of its 30% interest in its Amapa asset in Brazil; and US$542 million in non-cash valuation allowances related to two of the company’s deferred tax assets (in Australia and the United States). All of the write-downs will be posted in the company’s earnings for the fourth quarter of 2012.

“Overall we think the optics here look bad,” Anthony Rizzuto and Joseph Giordano of Dahlman Rose & Co. write in a research note. “We have seen and expect further write-downs at the other diversified miners, but not on their core iron ore businesses, as seen here.” The analysts, who have a sell rating on the stock, calculate that while the charges are non-cash, Cliffs “is writing down roughly 20% of its flagship asset, writing down its Amapa JV by 75%, and taking a tax loss due to lower price and profitability assumptions.”

Tony Robson of BMO Capital Markets in London told clients in a note that the fact that US$1 billion of the US$1.9 billion in write downs “comes as little surprise, given that BMO Research estimated at the time that Cliffs overpaid for the asset by US$2 billion.” He also valued the Bloom Lake mine in Quebec at US$2.6 billion on an attributable basis, including Phase II and III expansions.

“The asset impairments signify a confirmation of overpayment for Bloom Lake and Amapa historically and, though non-cash, reduce shareholders’ funds,” he continued, adding that “net debt to equity would change from 44% as at the end of 2012 to a pro forma [approximately] 60% post impairments.”

Cliffs paid $17.25 per share for Consolidated Thompson—a 31% premium to the Montreal-based company’s average share price for the twenty days prior to the offer. At the time, industry observers were forecasting a very strong market for iron ore for many years ahead, and companies like ArcelorMittal and Nunavut Iron Ore Acquisition were bidding against each other to acquire Baffinland Iron Mines Corp.

Cliffs will report fourth quarter financial results on Feb. 13.

The news sent Cliffs down US$1.18 or 3.2% to end the day at US$36.00 per share. Over the last year it has traded in a range of US$28.05-78.85 per share. Dahlman Rose has a price target of US$20 per share while BMO Capital Markets has a US$50 per share target price.