Cleveland Cliffs (CLF): CLF should have rallied, not dropped 17% - JP Morgan

JP Morgan notes they believe the extreme sell-off in steel stocks today can be largely attributed to a Bloomberg story Tuesday – “ArcelorMittal Says Half of Customers Rejected $250 Surcharge” - quoting Lou Schorsch, head of MT’s Flat Carbon Americas. The market interpreted this information as the steel producers are unable to pass through higher raw material prices with higher steel prices.

It should also be noted that the $250/t raw material surcharge, or as MT likes to call it “cost recovery program,” was implemented for their fixed price contracts which represent less than 50% of shipments and not for MT’s spot market shipments. Firm views the program as a success by achieving a 50% success rate given this unprecedented move in altering fixed price contracts.

With steel stocks in their coverage universe off an average of 15% in the last two days, they view this as an opportunity to gain an attractive entry point in a group with strong fundamentals that should see record high earnings in both 2Q and 3Q. While they believe most steel stocks warrant a strong rebound, firm's top picks in the group are Cleveland Cliffs (CLF), Nucor (NUE) and US Steel (X). CLF dropped $19.93 or 17% today and now trades at only a 2009 PE of 7.5x and EBITDA multiple of 5.4x. Thermal coal represents only 2% of CLF sales, and they see numerous positive earnings catalysts both this year and next for the company.

For those who read beyond the title of the Bloomberg article, they should have noticed that Mr. Schorsch stated that their iron ore prices from CLF will be up 60% in 2008 (compared to JPM's 26% forecast). If this was true, CLF should have rallied, not dropped 17%. NUE is trading at a 2009 PE of 7.9x and EBITDA multiple of 4.3x, near the lows of its historical trading range and recently raised its earnings guidance.

Notablecalls: Note the call was initially issued yesterday afternoon as CLF was trading around $104. I continue to view CLF as the prime bounce candidate in the coal-steel space. See more colour below.