This Materials Stock Should Make a Huge Comeback

Despite gains for the broader market this year, materials stocks have struggled in 2013. If you dig it out of the ground or use it to build stuff odds are the stock price has gone down so far this year.

The weak economy of the past few years has led to excess inventories of copper, iron ore, aluminum, steel and most other metals and minerals. Demand has been weak, and pricing has been weaker. We’re starting to see signs that Asia is stabilizing and Europe is inching towards recovery, so there is some hope the inventories are going to get worked off in the next year or two.

But we still have a long way to go.

Iron ore stocks have been among the worst performers this year. In fact Cliffs Natural Resources (CLF) is the single worst performing stock in the S&P 500 — falling by 45% so far this year. Iron ore prices fell by more than half as global stockpiles grew, and although they have recovered somewhat in the past few months, prices are still well below peak levels.

Cliffs operates five iron ore mines located in Michigan and Minnesota, five metallurgical coal mines located in West Virginia and Alabama, and one thermal coal mine located in West Virginia. The company also operates two iron ore mines in eastern Canada that primarily provide iron ore to steel producers in Asia and two iron ore mining complexes in Western Australia.

The Canadian operations were purchased in hopes that they would gain access to the faster growing Asian markets. Production at the Bloom Lake facilities has not come online as quickly as the company had originally calculated. The company spent more than $5 billion to buy the mines in 2011, and so far they have been a drag on revenues and profits.

The company has taken steps to weather the storm by cutting the dividend and refinancing its debt load. There are signs that the excessive supplies are being used and stronger economic activity in China in the second half of the year will further strengthen demand.

The real story — from a deep value guy’s point of view — is that the stock is simply cheap. The stock trades at just 60% of tangible value right now, and that’s a bargain no matter how you look at the iron ore situation.

At some point in the next five years or so, steel demand will rise, bringing iron ore prices and Ciffs’ profits higher. That will pull the stock price back to tangible book and higher. The last time the stock traded this cheaply compared to book value was in 2009 and the shares tripled over the next couple of years. I see no reason it can’t do the same over the next five years.

Cliffs Shares may go lower before they go higher because it’s a very volatile stock sensitive to economic news. I would start small in the stock with plans to add on significant weakness, but I see definite reason to buy, here.

As of this writing, Tim Melvin was long CLF.

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