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The Case For Cliffs Natural Resources (CLF)

 February 26, 2013 09:54 AM

(By Kevin Donovan) We've been watching the share price of iron ore miner Cliffs Natural Resources (CLF) with a gimlet eye since its precipitous decline earlier this month. Short-term speculators are probably wise to avoid what could be called a falling knife, but we think investors with a long-term horizon should take a look. 

The stock has been paddled mercilessly, hitting yet another 52-week low yesterday, after reporting dismal fourth-quarter results Feb. 13, slashing its dividend and diluting stockholders with a nine million share secondary offering of common stock.

Add to all that a subdued outlook and high cost structure, and Cliffs has quickly become a woodshed stock with few prospects for near-term resuscitation.  But management's prudence in shoring up the balance sheet and a key valuation metric argue that the stock has fallen too far and that patient investors will be rewarded.

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Cliffs cut its quarterly dividend some 76% to $0.15.  That was bad news for current shareholders, but the new dividend still yields 2.31% at the current share price.  Meanwhile, the company sold nine million common shares at $29 per share, putting buyers of the secondary under water.  But the actions had the desired effect of keeping Cliffs' debt rating at investment grade.  Standard & Poor's has  taken note, changing its outlook on Cliffs' to stable from negative and affirmed its corporate debt rating at BBB-minus, just above junk status.

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With its credit rating shored up, Cliffs retains the ability to borrow at reasonable levels to exploit growth opportunities, the largest of which is its Bloom Lake iron ore mine in eastern Canada.  The company indicated in its quarterly conference call that the mine would require more investment, perhaps $400 million more to get Phase II stripping and tailings done.

Costs aside, Cliffs been the victim of volatile pricing in iron ore.  Prices sank to $86.70 per ton in September from $180 a year earlier, Reuters reported.  With its high fixed costs, Cliffs' profit-loss ledger suffered mightily.  It reported adjusted earnings per share of $0.41 vs. $1.42 a year earlier.  Including impairment charges and other one-time charges, the company lost $11.36 per share. But iron ore prices have been on the rebound, reaching a reported 52-week high of more than $150 per ton recently.

Our linchpin for investing in Cliffs is valuation, specifically book value.  At the current share price, Cliffs trades some 23% below its stated book value of $32, which is our price target.  In short, if iron ore prices cooperate, Cliffs is worth more than the recent selloff is indicating.

Cliffs Natural Resources, based in Cleveland, Ohio, engages in the production of iron ore pellets, fines and lump ore, and metallurgical coal.  It operates mines in Michigan, Minnesota, West Virginia, Alabama and eastern Canada.


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