The recent earnings reports from steel companies have shown that there is significant overcapacity in the industry. This overcapacity continues to put pressure on steel prices. In turn, lower steel prices put pressure on iron ore and met coal prices. There is a company that produces both iron ore and met coal – Cliffs Natural Resources Inc (NYSE:CLF). The combination of the above-mentioned commodities has led to a 48% decline this year for Cliffs. The company’s recent quarterly report has shown that Cliffs Natural Resources Inc (NYSE:CLF) is on track to meet the challenging environment, however.
Coal sales jump
Cliffs Natural Resources Inc (NYSE:CLF)’ earnings came 29% above analysts’ expectations. The company has managed to generate $414 million in cash from operations. The ability to generate cash is crucial in current tough conditions. Commodities-related companies that are surrounded by doubt regarding their ability to generate enough cash to sustain their operations are punished hard by the market. The best example is Walter Energy, Inc. (NYSE:WLT), a pure met coal play that is down 69% this year.
Cliffs Natural Resources Inc (NYSE:CLF) has reported that its North America coal sales volume has increased by an astonishing 36%. At the same time, the company’s cash cost decreased 20% year-over-year. Because of cost management, Cliffs Natural Resources Inc (NYSE:CLF) was able to generate a coal profit despite the lower market pricing for coal.
This is the kind of performance that Walter Energy needs to turn its fortunes around. The company is stuck with $2.6 billion of debt on its balance sheet. In June, Walter Energy, Inc. (NYSE:WLT) announced that it was going to refinance its debt, but a week later the company has turned on this decision. The rates were too high for the troubled miner. Walter Energy, Inc. (NYSE:WLT) has since slashed its dividend by 92%. This has raised solvency questions among some investors and has caused the stock to tank once again. I’m supportive of this move, however, as it frees the much-needed cash for the company.
Iron ore sales improve too
U.S. iron ore sales were up 5.5% in the recent quarter from the same quarter of 2012. The domestic steel industry is still pressured by imports. Cliffs stated that steel imports continued to increase in North America, particularly from Japan and Korea. The strengthening of U.S. dollar has added to the pressure.
The iron ore market continues to be soft. This is a source of worry for companies like Rio Tinto plc (ADR) (NYSE:RIO), which gets 48% of its revenue from iron ore sales. Despite the soft market, Rio Tinto continues to expand its Australian and Canadian operations. Rio Tinto plc (ADR) (NYSE:RIO)’s iron ore production rose 7% in the recent quarter to a record 66 million tons. Rio Tinto plc (ADR) (NYSE:RIO)’s expansion of its iron ore production puts more pressure on an already weak market. In addition to that, the slowdown of China’s economic growth also threatens the iron ore market.
Valuation
Cliffs Natural Resources Inc (NYSE:CLF) has ended the quarter with $263.3 million of cash on hand. The company has paid down $110 million in debt from the revolving credit facility during the quarter. Cliffs is still highly leveraged with $3.3 billion of debt and a high 0.49 debt-to-equity ratio. In comparison, the diversified miner Rio Tinto plc (ADR) (NYSE:RIO) has a 0.46 debt-to-equity ratio. Walter Energy, Inc. (NYSE:WLT)’s results on this front are truly scary with a 2.76 debt-to-equity ratio.
Cliffs is attractively priced, trading at 12.63 its forward price-to-earnings ratio and 0.59 price-to-book. Rio Tinto plc (ADR) (NYSE:RIO) is trading at 8.15 its forward price-to-earnings ratio and 1.79 price-to-book. Despite the collapse of its shares this year, Walter Energy, Inc. (NYSE:WLT)’s 0.74 price-to-book ratio is higher than Cliffs’. No profit is expected from Walter Energy in the next two years.
Bottom line
Cliffs is a stable resource company that trades at attractive prices. The company has shown good dynamics and displayed its ability to stay profitable at current iron ore and met coal prices. Cliffs is dependent on the steel industry, as iron ore and met coal are two most important resources for production of steel. Once the steel industry rebounds, Cliffs is extremely well positioned to profit from it. In addition, the stock currently yields 3%.
Rio Tinto plc (ADR) (NYSE:RIO) is a dividend play that yields 4.03%. The company has a heavy exposure to iron ore. Rio Tinto continues to expand its capacity. All it needs now is the rebound in the prices. Once it comes, the company would be ready to extract money from it. Analysts’ mean target price suggests a 45% upside for the stock, and I believe this is possible in the longer term.
Walter Energy, Inc. (NYSE:WLT) could be facing liquidity issues. We will see whether this is true when the company issues its second quarter report at the beginning of August. Until then, I would not recommend taking any position in the stock, either long or short.
Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Vladimir is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article This Iron Ore Company Is A Buy originally appeared on Fool.com is written by Vladimir Zernov.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
