Headlines across the financial news today include a write-down of $6 billion by Cliffs Natural Resources (CLF). The write-down is on its seaborne iron ore and metallurgical coal assets as iron-ore prices have dropped more than 40 percent this year. Based on the more recent quarterly filing ending June 30, Cliffs had a book value of $6.028 billion. Writing down $6 billion will bring the book value to near zero. The company is still going to operate as this is not a cash event and the credit rating was already dropped to junk status (BB-) leading up the event.
The write-down is a learning opportunity for looking at price-to-book (P/B) ratios. The drop in equity will not be reported on the balance sheet until fourth quarter filing at the beginning of next year. Until that happens, the P/B ratio will be similar to what it is now, an extremely low 0.27. That is why it is important to further investigate the company before buying if such a low valuation is displayed. Before today’s news, it would not have been known that such a large write-down would have occurred. In hindsight, the signs were there for at least some kind of a write-down. Cliffs recently appointed Lourenco Goncalves as the new President, Chairman, and CEO in August. He came into the position with a 90-day plan for Cliffs. Combining that with plummeting iron-ore prices, a new CEO can take a huge write-down, get the bad news out of the way, and leave people with the impression that the worst could possibly be out of the way.
With low P/B ratios, it is important to look at the recent trend in book value per share (BVPS). If BVPS has been declining over the years, the P/B ratio might deserve to be below 1 in anticipation that the BVPS will drift down enough in the near future to where the P/B ratio will be in line with historical valuations. That would not have been the case with Cliffs, though. The BVPS actually looked to be stabilizing lately. The tip off here would have been the drop in iron-ore prices and realizing that its inventory of mineral deposits lost a large part of its value.
For now we can throw the low P/B ratio of 0.27 out the window. The P/E will be negative for a year once the write-down appears in the quarterly filing. The price-to-sales (P/S) ratio is only 0.31 now compared to its 10-year median of 1.30, but revenue per share has dropped 19.1 percent over the past 12 months. The 10-year annual growth rate in revenue per share is 14.4 percent. In comparison to its 10-year median, the current P/S ratio deserves to be a lower level with decreasing revenues, but not as low as 0.27.
Now with the large write-down, a book value of near zero, and negative cash-flow, there could be worries about whether the company will make it. Recent insider trades indicate that the company will.
There have not been any insider buys since November of 2013 until late August, just after the new Chairman and CEO took over. Four different directors were buying from August 21 to September 12. Legendary investor, Peter Lynch, mentioned in his book, One Up On Wall Street, that when insiders are buying, the odds are high that it will not go bankrupt within the near future. It might be enough time for Goncalves to get the company back on the right track. This might be a bottom in the stock, but I think it will be better to listen to the CEO detail the company’s strategy in the upcoming conference on October 28 before buying.
From here you can also monitor any further insider activity at GuruFocus. You can also see if any of the investing gurus are buying or selling.
Not a Premium Member of GuruFocus? Try it free for 7 days here!
