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Andrew Heyl
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Education: BA Economics                   JD Law Experience: I am a lawyer by trade, but have been studying economics and public companies for more than 20 years. I manage family retirement funds.  Disclosure: My articles and comments are solely my opinion, not an investment recommendation or... More
  • The Case For Cliffs Natural Resources  0 comments
    Mar 19, 2013 10:16 PM | about stocks: CLF

    Cliffs, like all the major iron ore miners, has taken a beating since it reached a triple peak in its share price in the first half of 2011 at a little over $100 per share. Iron ore reached it's monthly price peak in February 2011 at $187.17, and then declined steadily to a monthly price bottom in September 2012 at $99.47. Since then there was a steady climb in ore prices to February 2013, when the monthly price reached $154. It then declined to the present price of about $130.00. (see indexmundi.com) The bounce from the September 2012 low to the February 2013 high was substantial, but the stock price was somewhat lagging the ore price and did not come close to approaching it former highs. Then came the 4th quarter report, with the dreaded dividend cut, a huge charge off of it's recent purchase of Thompson's Iron Mines, and a proposed issuance of common and mandatory convertible preferred stock. (and oh yes a possible labor strike!). Even though there was a warning about the write off, and anyone following the stock should have known a dividend cut was probably advisable and at least a possibility under the present iron ore price predictions, it was too much for many stock holders to stomach, and the massive sell off began. I speculate management decided to get all the bad news out in one blow, rather than dribble it out over a year or two. In any event, it certainly did the trick in getting the stock price down, if they are interested in buybacks and cheap prices.

    There are several reasons for Cliff's present dilemma. First and primary is of course the decrease in iron ore demand and price, over the last 2 years, which has hurt all the iron ore miners. The second is that Cliffs, as did most the major players, purchased properties at the peak of the iron ore boom. This of course resulted in buying at inflated prices, which they, like several other of the major miners, decided to write down last quarter. The result being a massive one time loss.

    Cliffs major purchase was Consolidated Thompson's Iron Mines, Ltd., for a purchase price of $4.9 billion. Approximately $1 billion of that price was written off in the recent quarter, causing the loss. (although to a certain extent it was a paper loss, not actual, since a good portion was for good will). Without that write down, Cliffs would have had a annual net profit of over $100 million. Which in light of the decline of iron ore prices would not have been too bad. Never the less the sticker shock of the loss was too much for most shareholders to stomach and they ran for the hills. The dividend cut was also a no no for the stock price. Watch Jim Cramer on the subject. Shareholders just can't handle it. Ironically the $2.50 dividend had only been declared a year earlier. They would have been well advised to have kept the old dividend and declared a special dividend. If that had been done I doubt the fall out would have been as catastrophic.

    Cliffs proposal to issue preferred and common shares seems like a prudent way to solve any potential capital problems in the event the worst happens and the price of ore tanks again. This restructuring is a bit complicated, and I imagine many shareholders didn't try to figure it out and just bailed instead. In summary the preferred shares pay 7% and are mandatorily convertible in five years. This might be the best way to investment in Cliffs at this time. Unfortunately, this type of restructuring of capital is more than a bit unusual and, along with the other actions, didn't help the share price. Although the restructuring does dilute the shares, If the income is used to pay off debt it may be somewhat of a wash. In conclusion, the way this was handled by management has resulted in a decrease in the share price way below the company's tangible book value of $30. At this price it does indeed look cheep.

    The only thing at this time that would seem to be against holding the stock, is the almost unanimous speculation that the price of ore is again going to tank at the end of 2013, although not quite as bad a last year. Most believe it will stay between $110 and $130, good enough to still make a profit. The primary reasons for the decline being the anticipated slow down in China, and the anticipated increase in production that is scheduled to come on line in the next several years. With regard to China, who knows, or can even be assured of how accurate the figures are. From what I read China is planning on moving some 300 million people from the farm to the cities in the upcoming years, which is about the present size of the US population. Regardless of how many empty apartment buildings they have, 300 mil sounds like a lot of infrastructure. With regard to the number of iron ore developments coming on line, I think the speculators have not taken into account as to how many of these will be delayed if the iron ore price doesn't rise. Many of the projects like the Ring of Fire in Canada, are going to need a lot of infrastructure themselves including a rail road, if it is going to be feasible. The easy developments are long gone. I've read a number of articles from the major producers who are making rumblings about production cuts on less profitable projects. On March 11, Cliffs announced it was reducing some of its pellet capacity. As most people who follow commodities know, stopping and starting production is usually a multi-year event, which accounts for the wild swings in prices. Price is pretty much self-righting like a sailboat. There have been a number of report of new mining opportunities in recent months, but from what I read, they will all require time to develop and, more important, lots of money. It does seem that at some point in time there has to be a lot more demand if the world population continues to grow and develop. China with a population of 1.5 billion would be 5 times the present US population, India with 1. billion would be more than 3 times, and Indonesia coming up on the outside. If you have time to wait you might want to simply buy here, collect the dividends which are still 2.75% at the present price, and wait for the population boom to make you right.

    There is one more reason that Cliffs might have a silver lining and that comes by the name of Zenyatta Ventures, in which Cliffs has a significant amount of stock. Zenyatta has discovered what is thought to be one of the largest vein graphite finds in the world. If this turns out to be true, the profit could be huge. Until we find out more about the find, Cliffs' potential profit from such a development is highly speculative, but it is something to be watching. I did talk to a company spokesman about Zenyatta, but other than acknowledging their interest, they wouldn't give me much information, since this was in their exploratory subsidiary and they don't give out information on exploratory projects, for obvious reasons.

    Disclosure: I am long CLF.

    Stocks: CLF
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