Is Cliffs Natural Resources a Sell After a Goldman Downgrade?

With shares of Cliffs Natural Resources Inc. (NYSE:CLF) trading around $30.70, is CLF a Buy, a Wait and See, or a Stay Away? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s MovementMoney Cut in Half

Goldman Sachs slapped CLF with a downgrade on November 20, moving the stock from “Neutral” to “Sell” with a 6-month price target of $25 per share, a 29 percent downside from the closing price before the downgrade was announced, and an 18.5 percent downside from the stock price on November 26.

T = Technicals on the Stock Chart are Weak

As of November 25, the stock price is 12.94 percent below its 20-day simple moving average, or SMA; 19.43 percent below its 50-day SMA; and 36.67 percent below its 200-day SMA.

Since the beginning of 2012, the stock price has been in a steep downward trend, losing 53.38 percent of its value this year to date, and 48.59 percent year over year.

The stock is currently trading at the low end of a 52-week range between $29.80 and $78.85 per share with a relatively high beta of 2.45.

E = Earnings are not Increasing Quarter over Quarter

CLF’s revenue has been bumpy quarter to quarter. Revenue grew just 1.99 percent in the last quarter, after posting strong gains of 17.75 percent in the previous (second) quarter. However, revenue dropped 11.39 percent in the first quarter of 2012, and 24.91 percent in the fourth quarter of 2011.

Sept. 30, 2011 Dec. 31, 2011 Mar. 31, 2012 Jun. 30, 2012 Sept. 30, 2012
Revenue ($) in millions 1,896 1,424 1,262 1,486 1,515
Diluted EPS ($) 4.07 1.30 2.63 1.81 0.60

 

Earnings have been equally as volatile, only showing growth in one of the past four quarters. Earnings per share declined 67.03 percent in the most recent quarter, and 31.4 percent in the previous quarter…

E = Excellent Performance Relative to PeersMoney Plant

Many investors favor return on equity as a key metric to diagnose how well a company is performing.  On this metric, CLF shows strength when compared to competitors. CLF has an ROE of 15.13 percent, which compares to Peabody Energy Corp (NYSE:BTU) with an ROE of 14.08 percent, and Alpha Natural Resources (NYSE:ANR) with an unattractive ROE of -45.7 percent.

Operating margins are also critical for stock evaluation. On this metric CLF also claims the upper hand on its competitors with an operating margin of 17.16 percent, which compares to Peabody at 16.49 percent and ANR at -46.54 percent.

T = Trends Support the Industry in which the Company Operates

Earlier in November, analysts at Goldman Sachs warned investors not to buy the coal dip. Coal stocks tumbled out of speculative inflation after the election, exemplified by companies like James River Coal Co. (NASDAQ:JRCC) losing 37 percent of their stock price in the five preceding trading days.

Tremendous volatility in the coal market is nothing new but the price action over the past few months clearly indicates that the market is unsure what the real value of coal companies are and what the future holds for them.

The analysts at Goldman pointed at four major, short-term issues facing the U.S. coal industry: declining thermal coal demand as plants retire heading into 2015 and regulations prevent the opening of new plants; export competition from Australia and China; the still-depressed global economy burdening already over-taxed balance sheets; and the blunt reality that many coal and iron ore reserves in the U.S. are being dug out and coal seams are becoming more difficult to access.

Bulls counter that coal, and particularly metallurgical coal and iron ore, is sensitive to the poor global economy. Prices can expect a recovery when construction and manufacturing pick up. China, which is rapidly industrializing and investing hundreds of billions of dollars in infrastructure, can be counted on to demand more steel in the coming future.

A recovery in the price of natural gas would also lead to a recovery in coal prices. Data from the U.S. Energy Information Administration show that the wellhead price for natural gas has been increasing since April, and has come up over 51 percent through August. However, CLF is less sensitive to natural gas prices because most of its revenue comes from iron ore…

Conclusion

Goldman comments in its downgrade that CLF’s “announcement to delay its Bloom Lake expansion and curtail some U.S. operations underscores that in a relatively weak iron ore market, high cost producers life Cliffs will be at a greater disadvantage.”

The company’s ROE looks attractive but it’s sitting at the top of a struggling industry. The industry environment looks prohibitively difficult heading into the future and further drops in stock price seem likely.

Because of this and the metrics mentioned above, CLF is a Stay Away. At best, wait for economic conditions to fully improve, particularly in places like China, but as its stands CLF does not feel like a safe place to keep money in the short term.

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