Cliffs Natural Resources: A Look Before The Earnings Report

| About: Cleveland-Cliffs, Inc. (CLF)
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Summary

Cliffs' shares are under pressure ahead of the earnings report, which is due on April 27.

The downside in iron ore prices and concerns about the domestic steel market are the reasons for the stock's poor performance.

I believe that market exaggerates risks, especially on the domestic front.

I'm getting questions from readers about Cliffs Natural Resources (NYSE:CLF), and I guess it's high time for pre-earnings update. CLF stock has recently been dragged down by major downside in iron ore prices. Technical factors (the successful downside breakout of the $8.30 level) also contributed to the downside. In my view, it is highly unlikely that any major support catalyst will emerge before the earnings report. However, the report should provide significant support for the stock because the market expectations are clearly low:

The iron ore price slump happened in the second quarter and will have no impact on first quarter results. Yes, the stock market thinks about the future, but actual results always serve as a major catalyst. You should not underestimate the power of publicly presented facts. This works both on the upside and the downside. How many times have you seen a company near bankruptcy whose stock was trading around $1 only to collapse to $0.20 when the bankruptcy news were announced? Even if something is obvious, the stock market will react to news when they are announced.

Source: cmegroup.com

Iron ore prices fell fast on expectations of a dramatic supply increase. This downside implies that Vale (NYSE:VALE), BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) will make the same mistake once again. I want to see more factual support for such a thesis. Meanwhile, China's economy grows at 6.9% and steel production reaches record highs. Many observers are talking about the slowdown of the Chinese growth rates, which is, in my view, inevitable, but they fail to take into account the fact that growth happens from an ever-expanding base. I am not a big optimist on China, but I see no reason for panic either.

Domestic steel prices, the key driver for Cliffs' U.S. pricing, remain stable, and the trend is to the upside. Nucor (NYSE:NUE) has just reported its first-quarter earnings, and they look good with growth in both volume and average sales price per ton. I expect that we will see similar trends in the reports of other steel producers like A.K. Steel (NYSE:AKS) and U.S. Steel (NYSE:X).

I believe that there is a huge gap between market perception of what's going on in the domestic steel market and reality. First, the market decided that Trump presidency will bring immediate huge upside to steel prices. After it became clear that any infrastructure plan will take time to pass and implement, the market changed its opinion and acted as if we were to expect big downside in the steel market. The reality is likely close to a step-by-step movement to the upside, without huge swings that we see in the stock market. I expect that Cliffs' first-quarter results will reflect this positive trend.

The P/E metric is not always relevant, but here I would like to highlight that Cliffs is trading at P/E and forward P/E of less than 7. Typically, you see this when a company's business is in a decline. No one believes in a turnaround and the company's shares get cheaper and cheaper, pushing the P value down and, therefore, putting pressure on P/E.

In such cases, investors are talking about a "value trap" and more short-term oriented individuals are typically joking about the "attractiveness" of the company's shares. However, this is definitely not the case for Cliffs, whose sales volume will increase this year together with pricing. Perhaps, the turnaround is not that almighty as the most optimistic investors expected, but there are currently no reasons to panic.

Cliffs will announce its first-quarter results on April 27. I believe that the market underestimates Cliffs and will be positively surprised by the news. Longer term, iron ore is the main reason for concern while the domestic story looks solid.

Disclosure: I am/we are 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.

Additional disclosure: I may trade any of the abovementioned stocks.