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What’s Been Driving Cliffs Natural Resources’ Valuation

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Valuations

Valuation multiples are key metrics that investors consider carefully. With the help of relative valuations, we can compare a company’s valuation with its closest peers’ valuations. There are several valuation metrics that we can use.

For companies in cyclical industries such as steel and mining, the EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation, and amortization) multiple is the preferred valuation metric. The forward EV/EBITDA multiple tells us how a company is valued for each dollar of EBITDA.

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The graph above shows the forward EV/EBITDA multiples of different steel companies, some of which have captive iron ore mines. U.S. Steel (X) is trading at a substantial premium to its long-term trading multiples. Nucor (NUE), Steel Dynamics (STLD), and AK Steel (AKS) are also trading at a premium to their long-term trading multiples. Cliffs Natural Resources (CLF) is trading at a forward EV/EBITDA multiple of 11.0x compared with its last five-year average of 8.4x. While Cliffs might look expensive, it’s important to note that the company went through one of its worst phases in the last two to three years due to ill-timed investments, which led to burgeoning debt and losses.

Is Cliffs’ valuation justified?

Investors should also consider that even after the current 374% rise in Cliffs’s share price year-to-date, its price has only reached the level it was at last January when the US steel prices were 15% lower as compared to the current level. Moreover, given the management’s upbeat commentary in 2Q16, the earnings estimates should rise.

The outlook is looking better now as US steel prices have started to gain traction as a result of strong demand and lower imports due to high penalties. It’s important to note that for commodity (GCC) companies, valuation multiples tend to peak when the economic cycle is about to take a turn for the better. Markets start factoring better forward earnings before analysts upgrade their earnings guidance, and we tend to see analyst upgrades for earnings coming after stocks rise from the depths. At the same time, investors should note that the multiples might start looking bloated if better steel prices aren’t reflected in the earnings.

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