Roughly two months ago, I recommended that investors avoid Cliffs Natural Resources (CLF, Financial). Despite the beaten down valuation of Cliffs, I though the stock was headed for more trouble and was an ideal value trap. Cliffs has shaved off roughly 40% of its market cap since then, but the stock has still not bottomed.
Investors have been trying to call a bottom in Cliffs for almost two years now. Betting on a turnaround can be a lucrative investment, but the chances of a company turning around are pretty slim. Investors tend to get greedy and turn a blind eye to the risks of a potential turnaround candidate, which is what has been happening in the case of Cliffs Natural Resources.
Demand problem
Cliffs' revenue has fallen off a cliff over the last few quarters, and investors can expect this downtrend to continue. Cliffs provides iron ore pellets for steel producers who use blast furnaces. However, the steelmakers are slowly switching to electric arc furnaces due to their better efficiency and less pollution. Unlike blast furnaces, electric arc furnaces require scrap metal.
Since electric arc furnaces are becoming more popular, the demand for Cliffs' iron pellets is reducing. This has been one of the reasons why the company’s revenue has plunged massively over the last few quarters.
What’s worse is that electric arc furnaces are expected to continue growing in the future. Despite the recent gain in popularity, electric arc furnaces are used by just over 50% of steel manufacturers. However, with steel prices at multiyear lows, manufacturers are looking to cut costs by switching to electric arc furnaces. As a result, the demand for Cliffs’ iron pellets should continue falling in the coming days.
With iron prices already hovering near multiyear lows, a consistent fall in the demand of iron ore pellets will hurt Cliffs Natural Resources. For these reasons, investors should not bet on the company’s turnaround and should stay away from the stock.
Conclusion
After falling further, Cliffs Natural Resources is looking more fundamentally cheap. The stock is trading at a P/S ratio of only 0.06. However, as explained above, the stock has more room to fall. The continued decline in Cliffs’ iron ore pellets will have a negative impact on the stock in the long term. In addition, iron ore prices are expected to remain depressed for the foreseeable future. Keeping the above factors in mind, investors should continue avoiding the stock.
