Buy Cliffs Natural Resources Stock

| About: Cliffs Natural (CLF)

The slowdown in economic growth in China has affected all natural resource producers without exception but among the hardest hit has been iron ore where prices fell from $189 a ton to $85 before recovering to $137 a ton. One company that was badly hit was Cliffs Natural Resources (NYSE:CLF) an iron ore and coal producer based in Cleveland, OH. As earnings declined, share prices fell by 52% in 2013, making the company the worst performer in the S&P 500. Indeed many analysts seem to believe that a further drop in iron ore prices is already discounted at the current price.

About the company

Cliffs has five iron-ore mines in Michigan, and Minnesota, and seven coal mines in West Virginia, and Alabama, with additional mining interests in Australia and Latin America. It is also the operator of Wabush, an iron-ore mine in Canada. The company is comparatively small in the iron ore market in comparison to the largest miners such as BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO) and Vale (NYSE:VALE). The company sold around 42 million tons of iron ore and 6.5 million tons of coal in 2012.

Cliffs was ravaged largely by its problematic $5 billion acquisition in January 2011, of a Canadian iron-ore company whose Bloom Lake mining project has turned out to be highly disappointing. In addition, a dilutive equity offering, a large cut in the dividend, and fears of oversupply in the seaborne iron-ore market has spooked many investors. Cliffs earnings last year were $493 million (EPS of $3.45) a decline of 72% from 2011. Lower price realization for seaborne iron ore and higher costs at Bloom Lake took their toll on earnings. Revenue declined by 11%, to $5.9 billion and EPS could drop to $1.89 a share for this fiscal year, but should begin to grow in 2014 as production at Bloom Lake picks up.

Bloom Lake, which is located in Quebec, is at the heart of the company's strategy to take advantage of growth in Asia by increasing the production of seaborne iron ore. Bringing the mine into production has taken longer and cost more money than originally anticipated but the production target for 2014 is 14 million tons. Based on December production, the annualized output was 7 million tons compared to the target of 8 million tons and production costs this year are expected to be between $70 and $75 per ton against the original expectation of $40 to $45.

Second-quarter results

The company reported second-quarter earnings of $0.82 per share compared with $1.81 per share in the same quarter of the previous year with net income declining by 48% to $133 million. Excluding exceptional items such as an asset impairment charge of $68 million, the adjusted EPS of $1.13 per share was better than the consensus analysts' estimate of $0.61 per share. Revenues for the quarter were $1.48 billion, a decline of approximately 6% from $1.58 billion in the previous year but in excess of the consensus analysts' estimate of $1.44 billion. Cliffs showed $263.3 million in cash and cash equivalents as of June 30, 2013, compared with $159.2 million as of June 30, 2012, and long-term debt $3.32 billion as of June 30, 2013, compared to $3.61 billion as of June 30, 2012.

2013 outlook

The company has cut its guidance for selling and general expenses for the full-year 2013 from the previous figure of $230 million to $215 million because of a greater emphasis on managing costs. The full-year cash outflow guidance for future growth projects has also been reduced by $10 million to $75 million. However, the company now expects to spend roughly $1 billion on capital expenditures compared to the earlier guidance of $800 to $850 million because of additional expenditures at Bloom Lake on items like water management.

The bottom line

The company has bitten the bullet to resolve its problems by restructuring some of its debt, raising more than $900 million in fresh equity and slashing its dividend payout by more than 70% and saving $250 million annually. The dividend yield is still a highly respectable 3.3%. In my opinion, the company is now undervalued because any further declines in iron ore prices seem to have been substantially discounted in the current price and there is little downside to an investment in CLF. Things seem to be looking up and there is always the prospect of the company being acquired should share prices fall further. With the prospect of an attractive dividend yield and a rebound in iron prices Cliff's is definitely worth further due diligence in the basic materials sector.

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