JHVEPhoto
A month ago, I wrote about the tremendous transformation that Cleveland-Cliffs (NYSE:CLF) CEO Lourenco Goncalves has executed since taking over in August 2014. The stock of it and other commodity companies have continued to selloff as recessionary concerns create pessimism on future demand. Commodities are cyclical businesses without a doubt, but I believe Cliffs is attractively valued given the near and long-term future prospects, and any material weakness should ultimately be an opportunity for Goncalves to do his thing, which is creating value for shareholders. Already we are seeing signs of this, as Cliffs management, which includes CFO and son of the CEO Celso, took advantage of the volatility in the company’s bonds by buying a $307MM slug in the open market at a price of 92 cents on the dollar. This is a small example of smart capital allocation and is one of many reasons to like the future prospects of Cliffs.
In March of 2020, Cleveland-Cliffs completed its transformational acquisition of AK Steel, which made it the leading steel supplier to the automotive industry, despite previously being an iron ore producer predominantly. As we all vividly remember that same month is when the Covid-19 pandemic/lockdowns shutdown the automotive ecosystem for the first time ever. After a three-month interruption, automotive production restarted, but at greatly reduced levels due to supply chain constraints, despite strong demand. During December of 2020, Cliffs consolidated its leading position with the acquisition of ArcelorMittal USA, which made the company the largest automotive steel supplier by a very wide margin. This makes it the leading supplier to just about all of the largest auto manufacturers in the country. Automotive steel is becoming increasingly complex, and companies care more and more about how it is manufactured to meet ESG goals, and of course to maximize performance. Cliffs works intimately with them to fulfill their needs and the company has a very good view about future plans of the industry, which are clearly to electrify in hopes of catching up to Tesla (TSLA).
Cliffs has been thriving financially despite this leading exposure to the automotive industry, which has been lagging behind its potential production levels due to supply chain issues, mostly stemming from a lack of the appropriate semiconductors. This has resulted in a massive consumer backlog for cars, SUVs, and trucks, which should propel solid automotive sales for the next few years, especially if unemployment stays low. It’s hard to buy the new car you might want right now despite the higher prices unless you want to be on a long waiting list. To put this into context, in the six years leading up to 2020, North American light vehicle production averaged more than 17MM units per year, but in the last two years, the industry has only produced 13MM units per year. CLF’s management indicated that all of its automotive customers have indicated that their supply chain issues are easing. This could help create a bit more near-term stability in steel demand and in turn CLF’s earnings, as steel accounts for about half of the weight of the average car. Importantly, CLF supplies the steel for both combustion vehicles and EVs, which are likely to become an increasingly large part of the market. The construction market has been a big driver of steel demand over the last year and a half, which should continue to be decent, but will probably slow down a bit as recessionary fears crimp growth.
On July 22nd, CLF reported another very strong quarter with revenues of $6.3B, up from $5B in the prior year. Net income was $601MM, or $1.13 per share, which included one-time charges of $95MM, or $.18 per share. These numbers were down a bit from last year when CLF generated net income of $795MM, or $1.33 per diluted share. These charges included $66MM, or $.13 per diluted share for debt extinguishment costs, $23MM for accelerated depreciation on idling the Middletown coke facility, and $6MM for severance costs. The company dealt with an outage at its Cleveland Works Facility and decided to expand the scope of the work to get overdue maintenance done, at a period in time where automotive manufacturing is still slow due to the supply chain issues. These types of proactive decisions have upfront costs of course, but lead to less future issues, and the plant should be fully operational once again in August, as things ramp up. Through the first six months of the year, CLF has recorded revenues of $12.3B and net income of $1.4B, or $2.64 per diluted share. These figures are up from the first six months of 2021 when revenue was $9.1B, and net income was $852MM, or $1.42 per diluted share. Q2 adjusted EBITDA was $1.1B, down from $1.4B YoY. Through the first six months of 2022, adjusted EBITDA of $2.6B, up from $1.9B in the first six months of 2021.
Q2 steel product sales volumes consisted of 33% coated, 28% hot-rolled, 16% cold-rolled, 7% plate, 5% stainless and electrical and 11% other, which includes slabs and rail. Of the $6.2B of steelmaking revenue, $1.8B of sales were to distributors and converters, $1.6B were to the automotive market, $1.6B were to infrastructure and manufacturers, and $1.1B were to steel producers. Steelmaking COGS included $242MM in excess/idle costs, mostly due to the Cleveland blast furnace #5 outage. CLF and other steelmakers are also dealing with higher costs on inputs such as natural gas, electricity, scrap, and alloys. The Q2 steel selling price averaged $1,487 per net ton, which was an over $40 sequential increase, driven by higher scrap prices sold to other steel mills, and favorable fixed price sales renewals.
Free cash flow more than doubled from Q1 to $633MM, which enabled CLF to achieve its largest quarterly debt reduction since CEO Lourenco Goncalves took over. Free cash flow should continue to be robust, aided by declining capex needs, the accelerated release of working capital, and the heavy use of fixed price sales contracts. Management indicated that it expects to see further substantial increases in the average selling prices for these fixed contracts resetting on October 1st, which will allow the company to continue to keep improving its balance sheet leverage with net debt well below one times TTM adjusted EBITDA.
As of July 19th, 2022, Cliffs had total liquidity of roughly $2.3B. In Q2, CLF repurchased $307MM of aggregate principal amount of an assorted series of its outstanding senior notes at an average price of 92% of par via the open market. Cliffs also completed the redemption of its 9.875% secured notes due in 2025, which retired all $607MM in principal notes outstanding. These are strong capital allocation moves where the company is using its robust cash flow generation to continually improve the balance sheet, so that the company is more robust in weaker environments. In addition to these moves, the company repurchased 7.5MM shares at an average price of $20.92. As of the end of Q2, CLF had approximately 517MM shares outstanding, and I’d expect management to be aggressive on buybacks sooner than later, given that there are no major new CAPEX projects or acquisitions on the short-term horizon.
Management provided a solid guidance that based on the current 2022 futures curve, which implies an average hot-rolled coil steel index price of $850 per net ton for the remainder of the year, Cliffs would expect its full-year average selling price to be approximately $1,410 per net ton. This outlook is bolstered by the company being able to reset 1.7MM annualized tons of contracts on October 1st. At a recent price of $15.62, CLF has a market capitalization of roughly $8.07B and an enterprise value of $12.54B. TTM EBITDA is right around $6B, so investors are paying only about 2.1 TTM EBITDA for Cliffs. Despite spot steel prices dropping, Cliffs’ fixed price contract that are usually based on average formulas should continue to reset higher in the near term, providing strong short-term financial visibility to what will continue to be robust earnings. Even a paltry 3x times EBITDA valuation provides roughly 50% upside from current prices. If the stock continues to selloff, management can be expected to do the right thing, whether that be debt repurchases, stock buybacks, or strategic acquisitions.
Be the first to comment