2 Things You Must Believe to Bet Against Cliffs


Cliffs Natural Resources (NYS: CLF) shares have really taken a dive over the past few months. The stock is down more than 30% this year. With China's economy slowing down and recession in Europe, investors can't be faulted for shunning iron ore and metallurgical coal stocks in the short term.

While I'm optimistic about Cliffs as a long-term play, I realize that many investors are pessimistic. Some see the proverbial glass as not only half-empty, but also full of cracks. And laced with arsenic. For those of you in this group, here are two things you must believe to bet against Cliffs over the long run.

1.China won't grow
China accounted for 31% of Cliffs' total 2011 revenue. That's up 4% from 2010. If China's growth stagnates, Cliffs' earnings will almost certainly hit a great wall.

There are reasons for concern. Cliffs' primary Chinese customers are steelmakers, and the steel outlook in China looks grim, according to some analysts. How bad is it? Two large Chinese steel operations have actually expanded into the pig business -- not pig iron, but rather the kind of pigs that oink.

Potential gloomy scenarios for China include a meltdown in property prices. Fortune published an online article earlier this year stating that "a crash on the scale of the real-estate collapse in Japan in the 1990s is a virtual certainty." According to BBC, financial experts estimate that the Chinese economy is more dependent on housing than the U.S. was in 2007.

On the positive side, Chinese premier Wen Jiabao went on record stating that the Chinese government was committed to controlling housing prices. Chinese leaders are also projecting confidence that recent stimulus efforts will propel the economy to a steady recovery in the latter half of 2012. China is targeting annual growth of 7.5% -- slower than in the past but still strong in comparison with most countries.

2. North Americans won't buy many cars
China is big for Cliffs, but North America is even bigger. Sales to customers in Canada and the U.S. make up 54% of total revenue.

One customer accounts for more than a fifth of Cliffs' overall sales. And this customer, ArcelorMittal (NYS: MT) , happens to claim a 40% share of the major automotive steel markets. If North Americans aren't buying cars, Cliffs' earnings will more than likely crash.

A recent study by AlixPartners, a global business-advisory firm, gives some credence to the proposition that car sales will decline. The study found that several factors threaten auto sales growth, including persistent unemployment in the U.S., increasing overhead costs for automakers and their suppliers, and a demographic shift as Millennials place less value on cars than earlier generations.

U.S. automakers aren't encountering any of these problems at this point, though. June sales were strong, with all of the major manufacturers beating same-quarter results from last year. General Motors (NYS: GM) , for example, postedits best monthly sales numbers since 2008. GM's June results were up 16% compared with the prior year.

Glass half-full
Despite these potential issues, I see the glass as half-full. Cliffs looks like one terrific bargain to me for long term investors. The stock trades on a price-to-earnings ratio of 4.1. The price-to-sales ratio is a low 0.94.

In addition to sporting a low valuation, the company pays a dividend currently yielding 5.5%. Future troubles could jeopardize the dividend payout, but Cliffs shouldn't have any problems paying dividends in the near term.

A few of Cliffs' peers look pretty good through my half-full glass, too. BHP Billiton (NYS: BHP) has a low P/E of 7.4 with a dividend yield of 3.5%. Rio Tinto (NYS: RIO) 's trailing P/E of 15 doesn't look as inexpensive at first glance. However, the company's forward P/E is less than six -- close to the lowest level over the past five years. Its forward dividend yield of 3.9% looks attractive also.

Maybe doomsday predictions will prevail. China's economy could collapse. Canadians and Americans could quit buying new cars. The Mayan calendar could turn out to be accurate. Cliffs Natural Resources could flop.

If you think that just maybe China will continue to chug along and cars on this side of the Pacific will continue to sell, though, Cliffs might be a stock for you. This assumes, of course, that our Gregorian calendar keeps working fine come December.

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The article 2 Things You Must Believe to Bet Against Cliffs originally appeared on Fool.com.

Fool contributorKeith Speightshas no positions in the stocks mentioned above. The Motley Fool owns shares of ArcelorMittal.Motley Fool newsletter serviceshave recommended buying shares of General Motors. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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