Cleveland-Cliffs Stock: Cleaning House (NYSE:CLF)

Cleveland-Cliffs Inc. (NYSE:CLF) remains a stock that we love to swing trade. We last guided for a buy-in shares at $15 in December. The trade paid out nicely, but as shares moved well past $20 recently, we got a bit defensive, just knowing how this stock trades.

Well, Cleveland-Cliffs just reported earnings, and they were a double miss. Make no mistake, CLF stock had a great run the last month, but these earnings could result in a sharp selloff. That said, the company has set a floor for revenues, as it has raised its fixed price contracts multiple times in recent months, including raising automotive-related sales contract pricing by $100 a ton a few weeks ago. Now, that said, looking solely at the numbers reported, this was not a good report, let us discuss.

Revenue declines

Steel prices have come down over the last year, a result due in large part to the actions of the Federal Reserve to reduce inflation, which has led to commodity price softening. Despite the lower pricing, the revenue numbers held up, even if they have come down. In Q4 2022, consolidated revenues were $5.0 billion, falling 5.8% from last year, and missing estimates by $150 million.

The major problem we see right now is an expense issue. This is a result of higher input costs (inflation) and higher labor costs (wage inflation) largely. That said, you have revenues falling but expenses rising. Margins were crushed. Overall for Q4, the cost of sales was up 25% to $5.1 billion, while SG&A was up 4% to $116 million. However, costs are starting to trend in the right direction. The CEO in the release stated:

“We also achieved our targeted unit cost reduction of $80 per net ton, which helped us to partially offset the impact of lagged index pricing. Entering 2023, as our fixed price contracts reset higher, our unit costs continue to decline, and sales volumes improve, we believe our quarterly Adjusted EBITDA should progressively improve.”

The cost issue was certainly a problem but should improve. That said, here in Q4, the company’s adjusted EBITDA continued to fall. It was $132 million in Q4, and this is down from $1.4 billion in Q4 of 2021. Overall, the company lost $0.41 per share, missing badly by $0.12. That said, as things improve, and the company cleans house, EBITDA, and EPS will improve.

Valuation still strong, balance sheet improves

The valuation is attractive even with EPS expectations falling, along with the share price decline following this report. Now, handicapping the 2023 earnings is tough, but considering contract prices, and an expectation for expenses coming down, we can assume EPS is likely to be $2-$4. At $20, that puts shares at about 6.3X 2023 EPS. In 2023, CAPEX is being guided to be about 20% less than 2022 while steel shipments should be up 5-6% from 2022. On top of that, the balance sheet is getting stronger. There is still a lot of debt, but now down to about $4.25 billion worth, down from $5.3 billion a year ago. The company also repurchased $30 million worth of shares in the quarter, reducing the float, and still has $2.5 billion of liquidity.

Cash flow remains positive but is down sharply in the last few quarters. Operating cash flow was $489 million, while free cash flow was $262 million, down from $905 million last year, mostly with revenue being lower due to lower steel prices, and of course, expenses being higher.

The Cleveland-Cliffs stock has held up well despite the known move lower in steel prices, while expenses have crept higher. The rise in expenses so far, while weighing on margins and earnings, has not led to a massive retracement in shares. This is because volumes are forecasted to be higher, and even with the lower margin profile, management is forecasting progressive cost reductions as time moves forward. As such, the Street has not revalued shares drastically lower.

Take-home

We like the repurchases to boost value. We like that Cleveland-Cliffs Inc. is paying down debt. We do think CLF shares in the $20s are a bit expensive in a declining steel price environment but applaud moves to increase contract value. Should the broader market pull back from its currently frothy levels, we think Cleveland-Cliffs Inc. stock could go on sale. Tough to justify buying here, even if the company is cleaning up the cost structure of the business. However, we do like buying Cleveland-Cliffs Inc. in the mid-teens and see CLF as a great stock for trading.