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Wednesday, September 9, 2020

Rock scramble

Let’s review the latest with Cleveland-Cliffs, Inc. (CLF on the NYSE), America’s largest iron ore miner-cum-steel manufacturer and Grant’s pick-to-click on a pair of occasions last year.  So far, the results have been less than rewarding, with shares down 38% from an initial bullish analysis on June 28, 2019.  Now follows a review of what went wrong, and the prospects for this 173-year old corporate institution. 

Of course, the unpleasant events of 2020 figure prominently in the equation.  And as Cliffs mines iron ore and converts the ore into pellets which it sells to steelmakers, the price path of that trio helps guide CLFs corporate fortunes.   

A sharp post-COVID rebound in the price of iron ore (to $128 a ton from $74 in April) has been offset by a much lower premium for pellets ($28 from $70 in June 2019), while domestic spot steel prices of $535 a ton are far below the $940 per ton featured in the initial analysis.   

The company is also highly exposed to the health of the auto industry. With steel and iron ore shipments down 56% and 24%, respectively and vehicle production on ice for the bulk of the second quarter, Cliffs absorbed $159 million in idling costs, contributing to a $112 million Ebitda loss for the quarter (Ebitda stood at positive $248 million in the second quarter of 2019).  

Then, too, the March purchase of AK Steel Corp. for $3.1 billion (including the assumption of $2.2 billion in debt) followed by near-cessation of economic activity in the second quarter helped push CLF’s pro-forma leverage ratio to 8.6 times by Bloomberg Intelligence’s reckoning, the highest since 2016 when iron ore fetched less than $50 a ton. 

The bond market is wary, with B/1-single-B-minus-rated CLF’s senior unsecured 5 3/4% notes of 2025 remaining at 93 cents on the dollar for a 746 basis point spread over Treasurys, well above the 514 basis point pickup over Treasurys on the single-B-rated portion of the Bloomberg Barclays High Yield Index.

Of course, the auto industry has enjoyed a strong rebound after production all but shut down this spring, with August sales clocking at a robust 17 million seasonally adjusted annual rate according to J.D. Power.  In a phone interview with Grant’s today, Cliffs chairman, president and CEO Lourenco Goncalves noted that as dealers largely remained open during the pandemic while production was shut, inventory levels have dwindled, necessitating a pickup in output from auto OEM’s. 

Goncalves also noted that the evident shift toward suburban living from urban centers (see booming new home sales data) could act as a further secular tailwind, as does the relative popularity of SUV’s and larger vehicles, which comprise a relatively larger portion of CLF’s automotive revenue. The executive concludes that: “It’s a different approach for a different generation.”

A return to more normal conditions may provide relatively swift relief from that concerning leverage ratio.  On the July 28 call, Cliffs noted that net liquidity (as measured by cash and cash equivalents, along with lending capacity under the company’s asset-based lending facility) had risen to $1.25 billion from $982 million on June 30.

By way of preserving cash, CLF discontinued its $0.06-per-share quarterly dividend in April, equating to an annual savings of about $96 million.  Asked if a return to such payouts was in the cards, Goncalves replied: “No intention to reinstate the dividend. No one buys it for the dividend, they buy the stock for long-term returns.”  

As for buybacks, on which the company allocated $300 million towards in 2018 and 2019, the plain-talking Goncalves declared: “I will not be buying back stock for the rest of my life. It’s a fool’s game and might make a few investors happy for half an hour. It’s the only decision I regret in six years running CLF.”

Meanwhile, a resumption of near-baseline economic activity should help further ease liquidity concerns, as Cliffs management forecast idling costs of less than $50 million in the third quarter and of a negligible amount for Q4 during the July 28 conference call.

Coronavirus aside, the AK Steel integration has shown promise, with CLF management implementing some $151 million of synergies with its newfound unit to top its initial $120 million estimate. That helped bolster cash flow guidance to between $50 million and $100 million across the third and fourth quarter, well above the $30 million Wall Street consensus. At $7.4 billion, Cliffs enterprise value currently stands at a bit less than 10 times consensus 2021 Ebitda, and roughly 6.5 times both 2022 consensus and the aggregate CLF and AKS Ebitda figures for 2019.   

Skepticism remains widespread, with 23% of the float sold short. That’s up from 10% last summer but below the near 28% threshold reached in fall 2019.  Management has taken notice. Asked about a series of screeds against short-sellers and skeptical Wall Street analysts during investor events in recent years, Goncalves argued the following: 

Short-selling is a phenomenon driven by somebody else’s money.  No one is using their own money to short.  In our case, they short because they don’t do their homework.  It’s not a smart move to short CLF at this moment when we are in a clear auto rebound; there are better stocks to short.

Anyway, Cliffs bulls can take solace in a partnership-type of mentality from management, as corporate insiders have snapped up $1.2 million worth of CLF shares in the past year, with no open market sales over that period. Goncalves notes to Grant’s that: “We believe in our business and we put our money where our mouth is; sometimes we want to buy and we can’t. I would love to buy more, and so would the board.”

A businessman’s risk in the Rust Belt. 

Recap Sept. 9

A strong rebound left the S&P 500 nearly 2% in the green, leaving the broad index sitting higher by 5% year to date, while the VIX closed below 30 for the first time in a week.  Treasurys likewise changed direction from yesterday with the 30-year yield rising to 1.46%, while WTI crude bounced back to $38 and gold jumped to $1,956 an ounce. 

- Philip Grant