Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. Â This isÂ best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another companyÂ or by reviewing theÂ 5 Undervalued Companies for the EnterprisingÂ Investor.Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a specific look at how Cliffs Natural Resources Inc. (CLF)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance):Â Cliffs Natural Resources Inc. is an international mining and natural resources company. The Company is an iron ore producer and a producer of metallurgical coal. The Companyâ€™s operations are organized according to product category and geographic location: U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal, Asia Pacific Iron Ore, Asia Pacific Coal, Latin American Iron Ore, Ferroalloys, and its Global Exploration Group. The Company operates in four segments: U.S. Iron Ore, Eastern Canadian Iron Ore, North American Coal and Asia Pacific Iron Ore. In the United States, it operates five iron ore mines in Michigan and Minnesota, five metallurgical coal mines located in West Virginia and Alabama and one thermal coal mine located in West Virginia. It also operates two iron ore mines in Eastern Canada that primarily provide iron ore to the seaborne market for Asian steel producers. On May 12, 2011, the Company completed the acquisition of Consolidated Thompson Iron Mining Limited.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years -Â FAIL
- Dividend Record – has paid a dividend for at least 10 straight years -Â PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period -Â FAIL
- Moderate PEmg ratio – PEmg is less than 20 -Â PASS
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â PASS
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 2/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 -Â FAIL
- Earnings Stability – positive earnings per share for at least 5 years -Â FAIL
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â FAIL
|Value Based on 3% Growth||$15.51|
|Value Based on 0% Growth||$9.09|
|Market Implied Growth Rate||3.14%|
|Net Current Asset Value (NCAV)||-$35.32|
Balance Sheet – 6/30/2014
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
Cliffs Natural Resources does not qualify for either the Defensive Investor or the Enterprising Investor. Â The Defensive Investor has concerns with the low current ratio, and the lack of earnings stability or growth over the last ten years. Â The Enterprising Investor has similar concerns with the high level of debt relative to the net current assets, and the lack of earnings stability or growth over the last five years. Â As a result,Â value investorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities. Â From a valuation side of things,Â the company appears to be overvalued after seeingÂ its EPSmg (normalized earnings) drop from $4.40 in 2010 to an estimated $1.07 for 2014. Â This demonstrated drop in earningsÂ clearly does not support the market’s implied estimate of 3.14%Â earnings growth and leads the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well belowÂ the price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on Cliffs Natural Resources (CLF)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
Disclaimer: Â The author held a long position in Cliffs Natural Resources (CLF)Â but did not hold a positionÂ in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.