Over the last two years, I have recommended shorting/selling Cliffs Natural Resources (NYSE:CLF) multiple times. Cliffs has since continued its multi-year downward trajectory and the last 30 days were probably the worst as the stock lost over 35% of its value.
Despite the plunge, I don't think Cliffs has bottomed, and investors shouldn't bet on a turnaround as the company's prospects still look bleak. With iron ore prices hovering near multi-year lows and no revival in sight, I think investors should not expect a reversal of fortunes heading into 2016. While I don't think the stock is a compelling short now, I still think investors should sell it. Here are the reasons why.
Iron pellets are outdated
Cliffs Natural Resources supplies iron ore pellet to the U.S. steel industry. Given that steel prices have plunged considerably in the recent past, many steel manufacturers are reducing production. Falling steel production has led to a decline in demand for Cliffs' iron ore pellets. Cliffs relies heavily on the steel industry for revenue. Thus, the recent plunge in steel prices also had a severe negative impact on Cliffs.
In addition, iron ore pellets are used by companies that use blast furnaces to manufacture steel. Blast furnaces are much more expensive to operate than electric arc furnaces. As a result, many steel manufacturers are switching from blast furnaces to electric arc furnaces, and I expect this trend to continue.
With more manufacturers closing down blast furnaces and switching to electric arc furnaces, the demand for Cliffs' iron ore pellets is declining consistently. This transition has taken a toll on Cliffs as the company's revenue has plunged substantially over the last 12 months.
However, what makes matters worse for Cliffs is the fact that the demand for iron ore pellets may fall more as demand for electric arc furnaces is growing rapidly. Currently, electric arc furnaces account for about 60% of U.S. steel output. Clearly, this technology has a lot of room to grow. Hence, it would be safe to assume that the demand for iron ore pellets will continue to decline, which is a big headwind for Cliffs Natural Resources.
Clearly, the company needs to transform itself from manufacturing iron ore pellets to steel scrap - the primary raw material used in electric arc furnaces. However, such a transition would require large capital investment and the company already has a very poor cash position. Cliffs Natural Resources ended the last quarter with just $271 million in cash as opposed to debt of $2.8 billion.
The company is burning cash at a fast rate while failing to reduce its debt. And the interest expenses further had a negative impact on the company's profits. Given weak iron ore pricing, Cliffs' cash position should deteriorate going forward.
With the iron ore market currently plagued with oversupply, prices are expected to remain weak heading into next year. Thus, I don't see Cliffs Natural Resources' fortunes reversing anytime soon and would advise investors to stay away from the stock.
Cliffs Natural Resources has been falling for many years, but I don't think the stock has bottomed. Amid the weak commodity environment, Cliffs' woes will get worse. Moreover, the company relies heavily on the U.S. steel industry for revenue. Due to the growing popularity of electric arc furnaces, the demand for iron ore pellets will fall, and this is another headwind for Cliffs Natural Resources. The company also is highly leveraged, and its cash position should deteriorate due to low iron ore prices. Hence, I don't think Cliffs Natural Resources will turn around anytime soon and would still recommend investors sell the stock.
Disclosure: I/we 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.