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Cliffs Natural Resources Will Make a Great Long-Term Investment

By Michael Nielsen – Mar 17, 2014 at 1:30PM

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With a strong financial track record, cheap valuation, and a good long-term outlook, Cliffs Natural Resources is an outstanding investment opportunity that may generate significant gains for long-term investors.

Cliffs Natural Resources (CLF -1.25%) has gotten a bad rap lately. The stock has plummeted from its high of $100 per share in 2011, mostly due to a 2013 billion writedown on the future profitability of its operations and recent fears of lower iron ore prices in 2014 . Although the billion dollar writedown and softening iron ore prices  are both good reasons to be skeptical of Cliffs, I believe the stock price has fallen to a ridiculously low level that creates an outstanding opportunity for long-term investors. 

Cliffs is cheap
Cliffs Natural Resources generated $2.40 of profit per share in 2013. Currently its price-to-earnings ratio is less than 8 times its twelve month trailing earnings. Comparing that to the P/E ratio of the S&P 500, which is around 19 times trailing earnings, this company is cheap. Even if iron ore prices continue to slide in 2014, the current share price seems to have already factored this in. Also, the company has limited exposure to volatile seaborne iron ore prices . Not only is the company somewhat insulated from falling ore prices, it has actually been enjoying premiums for its high quality (65% iron) ore. It is likely that weakening iron ore prices will not affect the company as much as its stock price suggests.

Cliffs has already prepared for weakening iron ore prices
It seems to me that the market is viewing Cliffs as a static entity that will continue operating exactly the way it has regardless of changes in the market in which it operates. This is completely not the case. Cliffs is run by a talented team of executives who adjust the company's operations based on current and expected changes in the iron ore market. The company has responded to iron ore price fluctuations by streamlining its operations. The company reduced its total selling, general, and administrative and exploration costs by 32% in 2013 and expects to lower these costs by 31% in 2014. Cliffs also has lowered its budget for capital expenses in 2014 by a whopping 54%. Even if the price of iron ore continues falling, Cliffs' cost minimization will likely offset the lowered sale price by decreasing its total expenses. 

The long term outlook for iron ore seems as strong as ever
I won't get too deep into predicting iron ore prices in this article, but what I will say is that almost all of the factors that are weighing down the current price of iron ore (a Chinese credit squeeze, lowered forecast for Chinese housing expansion, increased Chinese iron ore inventory) are short-term factors. The long-term outlook for the iron ore market is still strong. In fact, BHP Billiton was quoted saying "BHP Billiton's long-term view of iron ore prices is still robust" and "we shouldn't let today's price influence our long-term thinking".

In its Q4 2013 earnings presentation, Cliffs claims that "credit reforms in China are expected to support stable growth for the long term" and "In the U.S. Cliffs expects healthy increases in Motor Vehicle production and construction activities to support demand for steelmaking raw materials". Of course there may be a conflict of interest in Cliffs' and BHP' outlooks, however I am still sold on the idea of a solid future for the iron ore market.

Bottom line
I really can't think of a better time to get in iron ore companies, especially one as cheap as Cliffs Natural Resources. Would you rather buy a company for $0.50 if it has a risk of going to $0.40 in the short run and a chance to go to $2.00 in the long run? Or would you rather buy a company for $1.80 if it has a risk of going to $1.70 in the short run and a chance to go to $2.00 in the long run? Personally, I would choose the former, but it is up to you and your risk tolerance to decide which scenario you would prefer. 

Michael Nielsen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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