As Cliff Natural Resources (CLF) continued its steady fall, analysts on average reduced their target price in shares by almost 5%. Even with the target price cut, analysts suggest that shares would rise 69% from the $17.61 close.
% Change in Target
Data Source: Bloomberg
Cliffs was very recently assessed as a company to sell on March 15 when shares were $22.09. Investors sold off shares by an even wider margin on March 15 after related metal prices dropped violently. Gold prices declined nearly 7% on the morning of March 15, and closed the day down 9%. Gold prices have not been at $1,400 since March 2011. Copper dropped to $3.23. Oil also dropped nearly $3 to $88.59. The net impact on Cliffs was fear: investors now value the company at a market capitalization of just $2.81 billion and a forward P/E of 10, while paying investors a dividend that yields 3.41%.
With resources stocks, led by gold, in the midst of a free-fall, investors are punishing companies that experienced weak quarterly earnings like Cliffs. It is too early to call a bottom for any company in this sector, but investors should look at Cliffs Natural Resource approaching a bottom. There are a number of reasons to support this view.
1) Buyout by Rio Tinto (RIO)
Competitors could circle around Cliffs after the company added its lead to being the worst performer on the S&P 500 for the year to-date. Barron's already speculated a possible buyout on April 6, 2013.
Cliffs reported having $195 million in cash and cash equivalents, while debt stood at $4.1 billion, giving the company a debt to market capitalization ratio of 1.46.
(millions USD unless otherwise specified)
Data Source: Kapitall.com
Rio Tinto and Vale would be the most likely buyer, given their market size and cash balance. The management team of Rio Tinto would need confidence in the purchase. Rio needed to take heavy impairment charges and cut costs for its ill-fated acquisition of Alcan Aluminum in 2007.
After the 5.8% share price decline, Vale is valued with a 2013 P/E 6.9. The company could acquire Cliffs to gain ownership of valuable Eastern Canadian and Australian properties.
2) Cost Control and Cash Flow
Cliffs idled its Wabush Pointe Noire pellet plant to control its costs. The company originally expected to produce as much as 10 million tons, with between 2.5 and 3 million tons coming from Wabush. The combination of reduced output and lower costs will help Cliffs manage at more conservative Capital expenditure and operating expenditure levels consistent with lower product demand.
3) Stabilizing Iron Ore Pricing
A concerted effort by all players to reduce iron ore could help stabilize iron ore prices. By raising the gap between iron ore pricing and the cash cost per ton of $65 - $70, investors will view Cliffs in a more positive light.
The average consensus price of iron ore is $124 per ton in 2013, $115 per ton in 2014, and $105 per ton in 2016.
Weak Q1 GDP figures were not anticipated for China. GDP rose 7.7%, but below the consensus forecast of 8%. Industrial production rose 8.9%, below the expectation of 10% growth. The weak results triggered money managers to adjust their exposure to companies like Cliffs to account for the higher risk exposure.
It is too early to determine when Cliffs shares will bottom. The company could re-test a 2008 crisis-low of $15.43 reached on February 1 2009 before calls grow louder for the company to be bought out at a premium. Considering that shares are nearly 70% consensus target price, the substantial discount on shares suggests that a takeover premium would need to be quite substantial. Should the economic reality be far worse than imagined, the takeover thesis would be negated because the larger firms would choose to conserve cash and reduce capital expenditures instead.