Too Much Pain at Cliffs

 | Nov 30, 2012 | 11:00 AM EST  | Comments
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One of my old friends got mugged this month. Cliffs Natural Resources (CLF), the largest iron-ore miner in the U.S., has been smacked for a 35% loss in the past five weeks. Thursday it closed below $29, down from about $44 in late October.

The decline, in my view, is overdone. Does the world still need steel? Can you make steel without iron? Yes, the questions are rhetorical.

Aside from that, Cliffs is basically the same company it had been when the stock hit $110 more than four years ago. Even as the stock has plummeted, sales and earnings have risen.

I don't own Cliffs for my clients at the moment, as I sold it earlier this year to reduce their weighting in basic materials. I did that because China is very important in determining the world price of most raw materials, and that country's economy was slowing down.

Today, China might still be slowing; it's hard to tell. But the risk-reward equation now favors buyers. At $29 a share, there's less risk and more potential reward in Cliffs than there was at about $60, which is where the stock was priced at the start of 2012.

What Ails Cliffs?

Of course, there are reasons the stock has fallen. Earlier this month, the company slowed down an expansion at its Bloom Lake mine in Canada because of the recently softened demand for iron ore.

Bears caution that investors' enthusiasm for iron-ore stocks depends on whether China continues its epic construction boom -- something that is now very much in doubt. China uses close to half of the iron consumed in the world, and it imports about two-thirds of what it consumes.

China's gross-domestic-product growth rate has decreased for seven quarters in a row. It came to 9.8% at the end of 2010, and 7.4% at the last measurement.

A recession in Europe isn't helping. It crimps demand for steel and, as a result, for iron as well.

On top of those fundamentals, tax-loss selling this month has been kicking Cliffs' stock while it's been down. Investors are selling to nail down tax losses in 2012.

Why Buy?

With these problems afoot, why buy the stock? There are several reasons.

For one thing, skeptics may be overly concerned about China. An economic growth rate of 7.4% still makes China the fastest-growing major economy in the world. Further, last week China announced that a gauge of manufacturing activity had perked up.

The European recession is real, and it could be nasty. But it won't last forever, and stocks usually anticipate the end of a recession by three to six months.

Cliffs gets more than 75% of its revenue from sales in North America, and the economies of the U.S. and Canada look fine to me.

To the extent that tax-motivated selling is driving the recent decline, November's weakness could turn into January's strength.

Finally, Cliffs' stock sells for only 6x earnings, and it yields more than 8% in dividends.

In all, I'm considering buying it back.      

 

John Dorfman is chairman of Thunderstorm Capital LLC, a money management firm in Boston. He can be reached at jdorfman@thunderstormcapital.com. At the time of publication, he and his clients had no positions in the stock discussed here.

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