Amid the carnage of the 20% bloodbath to which shareholders of Cliffs Natural Resources (NYSE: CLF ) were subjected on Wednesday, Fools may be mightily tempted to go Cliffs-diving for what they hope may prove a long-term bottom in what has become a most inglorious downward trajectory for the stock.
My colleague and Motley Fool Materials & Energy analyst Taylor Muckerman believes the resulting share price "could certainly be a buying opportunity" for long-term investors, and considers this a "perfect example" of the value investor's opportunistic mantra of buying when others are fearful. As a value investor myself, I am typically prone to a similar thought process, but in the case of Cliffs, I simply don't see a long-term bargain here.
My cautious approach to Cliffs served me well after the stock suffered an inglorious fall of 19% during another decidedly rough week last October. From that point, when I encouraged investors to "steer clear" of the stock, Thursday's collapse appended a further 18% drubbing. My words of warning were directed equally at income investors as well, since the persistence of a distressed margin structure and a severely impaired balance sheet appeared to place the company's unsustainable dividend "in serious jeopardy." This week, Cliffs announced a 76% reduction of the quarterly dividend to $0.15 per share. Although some sort of relief rally can commonly follow a fall this profound, allow me to convey some of the factors that still have me keeping well clear of this stock.
For starters, the important Bloom Lake iron ore mine in Quebec -- for which Cliffs has already recorded a $1 billion writedown relating to the 2011 acquisition of Consolidated Thompson -- continues to present what I would characterize as insufficient clarity as to the exact nature and extent of what appears to be a declining set of expectations from the mine. While the optimistic investor may interpret the $75 million increase to 2013 capital expenditures announced this week as a bullish signal of thawing market concerns, I have learned the hard way to remain vigilant toward the risk of substantial cost overruns from major projects of the sort.
Cliffs' coal unit has made impressive strides toward turning operations around from a cost structure that I flagged as "unacceptably high" back in 2010, but persistently weak pricing for metallurgical coal nonetheless had the unit joining Cliffs' Eastern Canadian Iron Ore unit in negative sales-margin territory for the fourth quarter of 2012. Unless the Wabush mine can achieve wholesale and immediate cost declines beneath the $166-per-ton reported for the quarter, some risk of curtailed or discontinued production there remains on my Foolish radar. I do expect some further strengthening of iron ore and met coal prices, but I expect that strengthening to be only moderate and weighted toward the back half of 2013.
Although the company has taken welcome actions to improve its balance sheet with this week's announcement of two separate share offerings (expected to raise roughly $800 million ) and the massive dividend cut, this will remain a heavily impaired balance sheet with -- in my view -- a risk of further impairment as the company struggles to return to profitability in a timely manner. Total debt at the end of 2012 stood at $4.1 billion, which is roughly equivalent to the company's current market capitalization.
Finally, these distressed Cliffs shares face stiff competition for investment capital among the slew of deeply impaired mining stocks, most of which I would characterize as possessing far greater long-term upside potential -- with substantially lower operational risks and far healthier balance sheets. Investors dying to dig for a bottom in met coal prices, for example, might do better to have a gander at Teck Resources (NYSE: TCK ) or Peabody Energy (NYSE: BTU ) . A more attractive entry point could soon arise for Teck Resources if the company follows through on its stated interest in securing a copper acquisition, since the industry's recent spate of horrendous asset impairments has investors reacting nervously to major acquisitions. Peabody recently took a writedown of its own, and as with Teck, I'm looking for strong contributions from seaborne met coal sales to render Peabody an exceptional long-term investment vehicle.
For the greatest bargains in mining, meanwhile, I urge value investors to take a long and careful look through the miners of gold and silver. A prolonged but moderate consolidation in gold and silver prices has accompanied an overdone thrashing of equity valuations among even the highest-quality operators in those industries. I couldn't possibly condone an investment in Cliffs Natural Resources, for example, while shares of Endeavour Silver offer multi-bagger potential with a far lower risk profile. Goldcorp offers a comparable dividend yield to Cliffs' adjusted payout, but it boasts an incomparably healthy balance sheet and far superior upside potential in the price of its principle product.