Walk Along the Fiscal Cliff With Cliffs

by Ethan Roberts | November 12, 2012 10:59 am

A carefully thought-out long-term investment plan should include ownership of some high-paying dividend stocks in the S&P 500 or Dow Jones Industrial Average. These are the strongest companies in America, so when they go on sale, it is time for prudent investors to sit up and take notice.

One such company now is Cliffs Natural Resources (NYSE:CLF[1]). Shares have fallen off more than 60% after peaking just below $100 in July 2011, and with its dividend yield inflated to almost 7%, the time has come to take a long look at this stock.

A Battered Miner

Cliffs Natural Resources, based in Cleveland, is a mining and natural resources company that produces iron ore pellets, fines and lump ore, and metallurgical and thermal coal mines in several states. It also operates iron ore mines in Canada that provide iron ore to steel producers in Asia, as well as other iron ore mining complexes in Australia and Brazil. The company has been in business since 1847.

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CLF’s recent performance has not been good, to say the least. The stock price has been cut in half over the last 12 months, and at the end of October, it gapped down from $43 on a really bad earnings report, slicing through the 50-day moving average (see accompanying chart). Higher costs and lower margins on iron ore were to blame for a really bad third quarter.

However, several positives still remain in effect. Cliffs’ return on equity is over 25%, and it’s trading at just 5.76 times earnings. Even though steep losses have juiced the dividend yield to 6.9%, CLF still is only paying out roughly 39% of its earnings, though that is above the S&P 500 average of 34%.

The current political turmoil over the “fiscal cliff” has dividend stocks on the defensive. We know it’s likely that we’ll see some kind of increase on dividend taxes — we just don’t know how much[2]. And that uncertainty has had an effect on stocks like Cliffs.

It was interesting to watch the stock’s performance on Friday. The stock began to rise in the morning, and was up around 6% following the speech by House leader John Bohener. However, after President Obama’s address, the stock began to decline, finishing up only around 3% for the day. Apparently, traders were not convinced that the two political parties are about to hammer out a deal to resolve their differences and fix the fiscal cliff issues.

Right now, we have both a challenge and an opportunity for stocks like CLF. The Obama administration has expressed its displeasure with the coal industry, and that has hurt CLF, although to a lesser degree than other coal stocks like Arch Coal (NYSE:ACI[3]) and James River Coal (NASDAQ:JRCC[4]). However, a more flexible attitude during Obama’s second term certainly would improve the unemployment numbers among coal workers in the Mid-Atlantic region.

Worst-case scenario, if both parties fail to resolve their differences on the fiscal cliff, CLF also would suffer when an increase in dividend taxes resulted in a continued punishment for dividend stocks. At some point, there also is a risk that CLF and other companies might be forced to cut their dividends, but Cliffs management so far has said they’re not cutting the payout.

One has to wonder, though: Given that CLF raised its dividend from 28 cents per share to 62.5 cents per share in April 2012, how long can the dividend endure at current levels?

CLF Options

For more advanced investors, it’s worth noting that the covered calls on CLF have been excellent and provide an additional source of income. For example, the December 22 calls with a strike price of $40 were about $1.02 at the close on Friday. At the current price, that’s an additional 2.7% of income.

If one bought 100 shares and sold that covered call, even without the dividend, there is a potential gain of 9.8% if the stock were to hit $40 before the option expiration date.

Bottom Line

It seems likelier than not that the fiscal cliff will be resolved one way or another, which means you can approach Cliffs with some confidence again. All in all, despite some risks, I think it’s an excellent time for long-term investors to add CLF to their portfolio.

As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.

  1. CLF: http://studio-5.financialcontent.com/investplace/quote?Symbol=CLF
  2. we just don’t know how much: https://investorplace.com/2012/11/dividend-investors-dont-panic-tax-rate/
  3. ACI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ACI
  4. JRCC: http://studio-5.financialcontent.com/investplace/quote?Symbol=JRCC

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