Cliffs Natural Resources Inc (CLF): How High Is Too High?

Cliffs Natural Resources Inc (NYSE:CLF)Cliffs Natural Resources Inc (NYSE:CLF) is up nearly 20% over the last week on hopes that various cost cutting plans and hopes that China’s importing more iron ore will help the company finally turnaround. Last quarter (1Q), the company managed to beat EPS by over 75%, this after having missed EPS by at least 5% for the prior three quarters.

Also, helping push the company higher was the upgrade by FBR Capital Markets, which boosted the company to outperform from market perform and placed a $28 price target on the stock.

However, the company is still down over 40% year-to-date, meaning that it has a long way to go before it can gain investors’ trust. Cliffs Natural Resources Inc (NYSE:CLF) is an international mining and natural resources company, focused on iron ore and metallurgical coal.

Cliff’s largest customer is ArcelorMittal (ADR) (NYSE:MT), which makes up some 17% of total product revenues. ArcelorMittal (ADR) (NYSE:MT) is involved in the mining and steel industry, and the biggest consumer of iron ore is the steel industry, so it’s only natural that ArcelorMittal (ADR) (NYSE:MT) has seen share price erosion just like the major iron ore companies. All the major iron ore stocks have taken a beating over the last five years, with Cliffs Natural Resources Inc (NYSE:CLF) and Arcelor being two of the biggest victims of the global economic slowdown.

Cliffs Natural Resources Inc (CLF) Still Has a Long Way to Climb

What’s more is that Cliffs’ three largest customers (Arcelor, Severstal and Algoma) account for over 30% of product sales and 60% of U.S. iron ore product revenues. One of the big headwinds will be China’s decelerating economy, and Cliffs Natural Resources Inc (NYSE:CLF) expects its global iron ore sales to be relatively flat year-over-year at about 40 million tons for 2013. As a result, the future outlook isn’t too bright for the company, with analysts expecting the company to grow EPS by an annualized 6% over the next five years.

How do the comps stack up?

Vale is a Brazil-based metals and mining company. Vale’s iron ore production fell by 3.5% year over year during 1Q 2013, after various licensing and permits issues. Heavy rainfall in Mozambique also contributed to a decline in the coal shipments in the region, and the mine of Gongo Soco will be shut down in 2013 due to excessive use.

Vale is still down over 20% year-to-date despite posting 1Q EPS that beat the consensus by 17%. As well, at the end of 1Q Vale’s cash on hand was $6 billion, while long-term debt increased to $44 billion. Despite the recent underperformance, analysts expect the company to perform nicely over the longer-term. Analysts have a five-year expected annualized EPS growth rate of 12%, which puts the iron ore company’s PEG ratio at a mere 0.57.

BHP Billiton Limited (NYSE:BHP) is a diversified natural resources company, which has potentially helped the company hold up better than some of its mining peers. The company operates in nine segments: Petroleum, Aluminium, Base Metals, Diamonds and Specialty Products, Stainless Steel Materials, Iron Ore, Manganese, Metallurgical Coal and Energy Coal.

Of all the major iron ore producers, BHP Billiton Limited (NYSE:BHP) currently pays the only dividend that is less than 100% of earnings, with a dividend payout of 61%. This in part, along with a strong backlog of projects, makes BHP the best iron ore producer in the industry. At the end of its fiscal half-year 2013, BHP Billiton Limited (NYSE:BHP) had twenty projects in progress, which are expected to yield revenue by 2015.

Moreover, BHP Billiton Limited (NYSE:BHP) has a competitive advantage based on its diversified portfolio of low cost and high quality assets. This may help the company derive profits from industrial and infrastructural transition across the world. Also, the company has been looking to divest non-performing assets to strengthen its balance sheet. In the half year 2013, the company divested roughly $4.3 billion of its assets.

Hedge fund trade

Going into 2013, Vale had the most hedge fund interest among the iron ore companies, with a total of 25 hedge funds long the stock, a 14% decrease from the previous quarter. The largest hedge fund owner was billionaire Jim Simons, with a $83 million position in the stock, comprising 0.2% of its 13F portfolio (check out Simons’ high yield picks).

In a close second was Cliffs Natural Resources Inc (NYSE:CLF), with 23 hedge funds long the stock. The top hedge fund owner was billionaire Steve Cohen’s SAC Capital with a $116 million position (see Cohen’s top five).

Coming in third, with only 14 hedge funds long the stock (a 30% decrease from 3Q 2012), was BHP Billiton Limited (NYSE:BHP). The top hedge fund owner by market value was billionaire Ken Fisher’s Fisher Asset Management, with a $529 million position that made up 1.5% of its 13F portfolio (check out Fisher’s cheap stock picks).

Don’t be fooled

The iron ore industry is tough to own right now thanks to the poor macroeconomic environment. The weakness in iron ore going forward will be driven by excess steel capacity, coupled with a slowing of nonresidential construction.

However, there are balancing factors on the positive side. These include an expected rise in U.S. GDP (S&P expects 2.7% growth in 2013) and an increase in auto sales, with S&P expecting sales to be 15.6 million units in 2013, up from 14.4 million in 2012. I remain cautiously optimistic about the industry, but for investors looking to gain some exposure to iron ore, their best bet looks to be BHP Billiton Limited (NYSE:BHP), based on its valuation and its solid dividend.

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