MorningWord 4/14/15: Miner Threat

by Dan April 14, 2015 9:20 am • Commentary

At this stage of the game it’s become clear that the rise and fall in commodity prices over the last few years was a direct result central banks’ (primarily our Fed) monetary policies since the financial crisis.  While most financial pundits concerned themselves with the brewing bond bubble from QE and ZIRP or silly valuations in social media and 3D printing stocks, the commodity bubble inflated and then popped, and we’ve only felt some of the repercussions.

As we get a read on Q1 earnings, we are just now feeling the affects in corporate earnings. Despite the benefit to companies of lower input costs, or consumers who have more cash in their pockets from paying less at the pump, the S&P 500 could print its first year over year quarterly earnings decline in almost 3 years.  This is obviously backward looking. And the S&P 500, at less than 2% from its all time highs, doesn’t seem too bothered, suggesting that a weak Q1 is baked in at this point.

But looking forward a bit, we could be on the cusp of swath of defaults and/or bankruptcies in the commodity/mining complex. Cliff Natural Resources (CLF) an iron and coal miner, caught my eye yesterday as there was some unusual call activity. From Monday’s Notable Post:

when the stock was 4.78 a trader paid .34 for 20,000 July 6 calls, the company is slated to report earnings April 24th.  The stock has been banging along multi-year lows for the last month and shockingly down 95% from the all time highs made in 2011, and short interest sits at 52% of the float.  As always with unusual options activity, it is impossible to know a trader/investor’s intent of a trade, and while some my consider this call purchase a bullish play but could also be a way to protect a short position.

I think the last point there is an important one. It’s easy to look at this chart knowing that with half the float short, it wouldn’t take much to cause an epic short squeeze. But who knows. Maybe the shorts will continue to be right. And maybe the stock is a zero?

CLF 4yr chart from Bloomberg
CLF 4yr chart from Bloomberg

The implosion in the commodity bubble has some of the casualties looking like stocks like dotcom bubble implosions like YHOO in the early aughts.  YHOO declined 95% from its early 2000 peak to its Oct 2002 low:

YHOO 1998 thru 2002 from Bloomberg
YHOO 1998 thru 2002 from Bloomberg

There is one massive difference though. While YHOO’s business model was distressed near its bottom, its balance sheet was just fine. They were not saddled with debt and merely needed to cut costs and refocus.  The post apocalyptic plan for commodity companies looks very different, especially if they do not see a pick up in prices and/or demand.  If commodity prices don’t rally, CLF’s ability to service its debt could become a challenge as earnings are expected to swing to a loss in 2015, from a peak of $11.86 a share in 2011 and sales expected to be around $3 billion, down from $6.8 billion in 2011.  The company has a market cap of $728 million, has $290 million in cash and equivalents and $3 billion in debt.

So when you see unusual call buying in what is becoming an increasingly distressed equity, it may not always be what you think.  Morgan Stanley recently lowered their 12 month price target on CLF to $3, and it seems that analysts have abandoned the stock with only 1 buy rating, 9 holds and 10 sells.   Here is a situation where sentiment matches the company’s current outlook.   This by no means suggests press the short, the situation is a bit asymmetric, which is one reason why the calls that were bought yesterday may be expensive in vol terms, but could prove to be dollar cheap if the stock ever had a reason to rally.

If we were to see further consolidation in oil stocks maybe it could flow over to miners, and put a floor under some of these stocks, but it will also take commodity/demand reflation to keep some of these companies afloat.