Cleveland-Cliffs Stock: There Have Been Changes (NYSE:CLF)

Once again we have to talk about some new and bullish developments for one of our favorite trading stocks, Cleveland-Cliffs Inc. (NYSE:NYSE:CLF). This is a stock we have traded a lot and follow quite closely. For a while, we have been surprised that the stock is as low as it is, on a valuation basis. The conventional wisdom is that inflation will come down and lower metal prices and that the Fed will cause a moderately painful recession and crush demand. Going beyond that, a lot of bears complain that management is not returning enough capital out of cash flow, and cash flow has not been this positive in a long time. Instead, management telegraphed that it will use cash flow to repay debt rather than fund a dividend or repurchase shares.

The stock in our opinion seems like it should be much higher, yet sets up for nice trades every few weeks. Every time the stock gets some legs to around $20, it likes to pull back. Well, we think it will have legs to $20+ on three new developments that we believe are bullish. Let us discuss.

Steel is cyclical but Cliffs just raised prices

While the overall price of commodities does fluctuate, Cliffs has some pricing power. As we all know steel is a commodity and Cliffs, for better or worse, trades largely with the price of steel, as well as iron ore. We know the price of steel is rather cyclical, being largely influenced by commercial and industrial demand, as well as “good times” economically. If you have been following this sector, you know that steel pricing has been on the decline this year, mostly from the Federal Reserve’s fight to decrease inflation.

With the Fed’s actions, we are in a recession by definition, but we are not feeling it yet, other than on regular expenses. However, as inflation runs rampant and things are becoming so very expensive, it stands to reason the economy will slow, especially as the cost to borrow money has gone way up. And, it is believed that if things worsen, we could have a moderate recession which would crush markets and likely wreck steel demand. But for now, steel demand is up, especially in the automotive sector.

Obviously, trying to lower inflation means that the Fed will effectively lower commodity pricing. This is elementary. So you should have expected commodities to retract a bit. But this Cleveland-Cliffs has transformed itself from an iron ore company into a steel company, and one that is doing well.

That said, the company just raised prices which will help revenue. They raised current spot market base prices for all carbon steel hot rolled, cold rolled and coated steel products by a minimum of $75/ton. Those prices will benefit Q3 2022 and beyond, as they are effective with all new contracts immediately. This is a bullish development. Cliffs recently reported earnings, and in the release, management gave a view of a “full-year 2022 average selling price expectation of $1,410 per net ton.” So, raising prices $75 (at least) is a minimum of a 5.3% increase of what was expected.

Now, you may be thinking future selling prices for contracts could come lower, but this is not necessarily the case. This is a very bullish development. While it is effective for only North American orders, pricing could change globally soon as well.

Performance is already down from peaks, but still strong

This bodes well for a company that many fear will see revenue fall hard. Keep in mind that Q2 saw performance already starting to fall, despite being strong. Revenues were $6.34 billion, rising 26% from last year. The company’s EBITDA and EPS remain strong, for the most part. Cliffs’ adjusted EBITDA of $1.1 billion in Q2 of 2022 was down sequentially, though, it was also a touch lower from last year’s $1.4 billion. So keep in mind that adjusted EBITDA was $2.6 billion through H1 2022 vs $1.9 billion through H1 2021, so it is up, but it may be that Q1 2022 was largely a peak. While the last 12 months’ EBITDA was $6.2 billion, an all-time record, you can fully expect this number to ebb lower in coming quarters.

So, the news of a price increase helps to feed all of these figures moving forward. We believe this is bullish.

You can’t sell this steel without labor

The companies we invest in would be nothing without their labor force. This is without question. While there are many debates regarding the benefits and drawback to labor unions, the fact is large unions carry a lot of weight. The good news is that over the last three weeks we have seen two tentative agreements reached with Cliffs’ labor force. This is important. While labor costs are rising everywhere, and that is a large expense for Cliffs, the company could not sell its products without the labor to make them. Perhaps the price increase aforementioned was to offset some of these costs? Possibly.

The first deal was reached two weeks ago and avoided a strike. A strike would have hurt. The agreement with the United Steelworkers union was a four-year agreement. The new contract covers 12,000 employees. It will include betters wages and increase insurance plan options without increasing costs to employees, but also came with a hefty investment in facilities totaling $4 billion.

Then, this past week, another deal was reached covering 2,000 employees involved in mining-type operations. In this deal, when ratified, the company will expand for nearly four years agreements on wages and insurance. Now, considering the company employs about 27,000 people, this means new deals have been reached for well over half of all employees. Lourenco Goncalves, who is the Chairman, President and CEO, and led the turnaround in Cliffs, seems to “get it.” He stated:

“Reaching a second labor agreement in less than two weeks reaffirms our great alliance with the USW. It also confirms one more time that we know very well our responsibilities as the supplier of choice to clients in critical sectors, such as military and automotive. We have now demonstrated twice why Cleveland-Cliffs gets things done and how we act: we negotiate respectfully, fairly and privately. A strong workforce is critical to our present and future competitiveness, and we look forward to continuing our shared success with our USW partners.”

So he understands he has a powerful union to deal with but also understands they provide a very vital service, and are what keep the company running. When you consider the fact that the company is raising prices, and other steel experts think the downside in steel is limited, having labor to meet demand is key.

We also have to add that these developments, in conjunction with reducing debt on the back of strong cash flow, suggest the stock is a buy here.

Cash flow powers lower debt

This stock has a price to cash flow of less than 3.25x on a forward basis because cash flow is so strong. While performance could be at a near-term peak, Q2 just saw the best free cash flow-driven debt reduction in company history. Cliffs generated $633 million in free cash flow. Winning. This was more than double Q1, which in many ways could have been a peak. Because of this, Cliffs saw the company’s largest quarterly debt reduction ever. Cliffs knocked the debt down to about $4.6 billion and repurchased 7.5 million shares in the quarter. We are in fine shape here

Take home

A recession, if it is bad, will crush most companies and stocks. Some will be hit very hard, some moderately, and some only a little. Steel demand could suffer, so Cliffs likely would be moderately impacted, and the market is pricing in a ton of this risk, maybe overpricing it in. For now, the company has made 3 key moves in raising prices, reaching a deal with 14,000 employees in a plethora of steelmaking facilities, and another 2,000 in the mining space. We think this is bullish, and the market is starting to bid the stock up.