Basic materials are frequently attractive as income plays. But they can also be fundamentally undervalued. In this article, I will run you through my DCF model on Cliffs Natural Resources (NYSE:CLF) and then triangulate the result with a review of the fundamentals compared with Vale (NYSE:VALE) and BHP Billiton (NYSE:BHP). I find that Cliffs is significantly undervalued, even when assuming for a slow growth rate. I am especially optimistic about the company taking over this company.

First, let's begin with an assumption about the top line. Cliffs finished FY2011 with $6.8B in revenue, which represented a 45.1% gain off of the preceding year. The year before that, the company's revenue doubled. I model per annum growth of 0.71% over the next half decade or so. This is extremely bearish in order to prove my point.

Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 63% of revenue versus 4.2% for SG&A, 22.5% for R&D, and 5.2%. Taxes are estimated at 25% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)

We then need to subtract out net increases in working capital. I model this hovering around -15% of revenue over the explicitly projected time period.

Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $90.74 for 35.2% upside.

All of this falls within the context of improving fundamentals:

Looking back on 2011, I'm extremely pleased with the record financial performance our management team accomplished, particularly in light of the strategic transactions and operational expansions and challenges we faced in the year. In addition to completing the $5 billion acquisition of Consolidated Thompson, we also remained on track to complete our 11 million ton per year expansion at the Koolyanobbing complex in Australia on time and within budget. We restored Oak Grove's overland conveyor system and prep plant after severe damage caused by a tornado. We restarted the Pinnacle Mine after shutdown earlier this year and achieved significant lower cash cost per ton. We also achieved the 8 million ton run rate at Bloom Lake Mine and completed approximately 20% of the mine's Phase 2 construction.

From a multiples perspective, Cliffs is equally attractive. It trades at just a respective 5.7x and 5.9x past and forward earnings versus 5.2x and 6.3x for Vale and 8.7x and 13.8x for BHP Billiton.

Consensus estimates for Vale's EPS forecast that it will decline by 17% to $3.62 in 2012, and then by 0.8% and 5% more in the following two years. Assuming a multiple of 9x and a conservative 2013 EPS of 8x and a conservative 2013 EPS of $3.53, the stock would hit $28.24 for 25.2% upside.

Consensus estimates for BHP Billiton's EPS forecast that it will grow by 11% to $4.74 in 2012, grow by 12.7% in 2013, and then decline by 15.7% in the following year. Assuming a multiple of 13x and a conservative 2013 EPS of $5.30, the stock would fall slightly. At the same time, the company offers the highest dividend yield at 3.1%. But, like many basic material companies, volatility is still high at a beta of 1.4. Accordingly, I recommend investment in companies with higher upside, like Cliffs and Vale.

**Disclosure: **I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.