Why Cliffs Natural Resources Is Falling, And How It Can Help You

Jan.12.14 | About: Cliffs Natural (CLF)

Cliffs Natural Resources (NYSE:CLF) is falling at the moment. As of Friday's close it stood at $22.83, a considerable drop down from its very recent high of just short of roughly 26.50 at the start of the year.

So, why was CLF falling during last week?

From what I found, no recent news items should have significantly impacted CLF within the mainstream financial media. Quite a few Tweets however indicated that it is the result of The Cowen Groups recent downgrade of Walter Energy (NYSE:WLT) and Alphas Natural Resources (ANR) which have business interests that are similar to CLF. The general sentiment from Twitter is again reiterated within the blog posts written by various confused investors of CLF.

So, the current thinking seems to be that since WLT and ANR produce coal for the steel industry, and CLF does as well, then as a result of WLT and ANR getting downgraded, CLF ought to also fall. Does this make sense? Possibly - to a confused market. But it doesn't make sense to the knowledgeable investor for the following reasons:

1. WLT and ANR are coal mining companies that sell metallurgical coal to the steel industry. A downgrade for WLT and ANR, however legitimate, should not necessarily coincide with a lower price for CLF. CLF only derives 11.5% of its business from metallurgical coal (see chart below taken from the most recent 10-Q).

(click to enlarge)Click to enlarge

WLT and ANR derive nearly 100% of their business from coal sold to the steel industry. Iron Ore is about 90% of the business that CLF does, so the recent downgrade of WLT and ANR should have little impact on CLF.

2. Perhaps, building on point one, a person might think that the steel industry has had a decrease in production which would correspond with the decrease in coal consumption utilized for the production of steel as well as Iron Ore. This could therefore be a legitimate reason for CLF to fall as a result of a corresponding downgrade in ANR and WLT. This would make sense except for the fact that steel production is higher by 3.6% as reported in November 2013 versus November 2012 as reported by the World Steel Association. In addition to this, steel production is expected to continue to increase throughout 2014 according to Zack's Investment Research.

If steel production is increasing while steel demand is increasing, then the price of Iron Ore ought to increase, right? Yes, as I indicated in an article on the steel industry these factors should favor CLF (although they might cause trouble for the average steel company). Furthermore, as indicated in the Economist, the major issue for the steel industry is the bargaining power of suppliers with respect to Iron Ore. While this might be a problem for the steel industry, it is certainly not for CLF. In fact this should be advantageous for CLF as the limited availability of Iron Ore will drive the price up, and consequently their profit margins.

Conclusion:

At the moment, CLF might be suffering from a recent downgrade occurring to seemingly similar companies (WLT & ANR). However CLF is considerably stronger then WLT and ANR due to it's position in the Iron Ore market. As a result, CLF will most likely be down for the near future, but up in the long-term. In the mean time, those investors that originally missed purchasing CLF at a good price, now have a new opportunity to do so.

Disclosure: I am long CLF, . 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.