If you're thinking about shorting Cliffs Natural Resources (CLF -1.79%), you aren't the only one. By last count, more than 35% of the company's publicly traded shares are held shot, and that number has been on the rise. So what exactly has so many people thinking that Cliffs' shares are headed down the drain, and is it worth following them down the rabbit hole by shorting the stock? Let's take a look.
A miserable market and a management mix-up
I could give a long description about how miserable business has been for steel producers lately, but I think it's just easier to look at this chart.
Iron Ore Spot Price (Any Origin) data by YCharts
In a matter of three years, the price per ton of iron ore has been cut in half. The reason for this, more than anything else, has been weak steel demand in China. To many, the idea that one country can completely swing the global market sounds a bit absurd. That is until you look at global steel demand. According to the World Steel Association's 2013 statistical review, China consumed 53% of the world's raw iron ore. So China's appetite for steel has waned as the country focuses less on infrastructure and construction-led growth and more on consumer-led growth, and it's taken the price of iron ore with it.
As you would expect, prices for metallurgical coal have also taken just as steep of a dive as iron ore prices over the past couple years. At today's metallurgical coal prices of $119 per ton, a vast majority of the world's supply is losing money.
Source: Walter Energy via Bloomberg Industries
These two events, combined with Cliffs' 2011 acquisition of Consolidated Thompson's mines in Canada, have all wreaked havoc on the company's profitability. While some of its operations -- such as U.S. Iron Ore -- have been able to remain profitable thanks to their low depreciation costs, other parts of the business such as Canadian iron ore and metallurgical coal have been hemorrhaging money for some time now.
Then to add insult to injury, the company has been in the middle of a battle for control of the chairman's spot. Casablanca Capital, one of the largest shareholders in the company, has been able to put several hand-picked people on the board, which has given them the power to select new chairman, president, and CEO Lourenco Goncalves. Part of Casablanca's plan as an activist investor in the company is to execute some massive sell-offs of its less lucrative assets and focus just on its U.S. iron ore business.
So let's see: bad commodity market + unprofitable business segments + proxy war for leadership of company. Yup, those sound like the traits of a company that many people will want to short.
Why shorting may not be the best idea
Before you log into your brokerage accounts to start betting against Cliffs, there are some reasons to think that the company might not be in as bad of shape as those already shorting the stock might suggest. One thing that Cliffs does have going for it is that the company's isn't in dire financial straits. While earnings have been weak as expected, the company hasn't been incurring huge cash cost shortfalls from operations and capital expenditures yet. Also, the company's debt profile isn't completely overburdensome; with a debt to capital ratio of 31.7% and an interest expense to EBITDA ratio of 6.9x, there doesn't appear to be any imminent risk of a default anytime soon.
The last thing to consider that may make you rethink shorting Cliffs' stock is that the company is already extremely cheap. At today's prices, cash on the balance sheet makes up 21% of the company's market capitalization, and shares currently trade at 30% of the tangible book value of the entire company.
What a Fool believes
To say there isn't room for shares to fall any further would be naive, because shares can always drop for rational or irrational reasons. However, considering that Cliffs isn't really in a spot of bother financially and share prices are already depressed so much to the point that market capitalization is less than the company's current assets -- something that Benjamin Graham loved to see in stocks -- then the possibility of making a gain on a short position looks pretty slim today.
