In December 2019, Cleveland-Cliffs (NYSE:CLF) stock rallied by 18% from $7.50 to $8.86 after the company’s announcement to acquire AK Steel (NYSE:AKS). The CLF stock rally fizzled out soon and the stock currently trades at $7.
The downside certainly doesn’t imply that the markets are negative on the acquisition. However, the focus is on near-term factors that currently overshadow long-term positive triggers.
Before talking about the fundamental factors, I want to add that CLF stock has remained sideways for the last four months. From a technical perspective, the stock has found support in the range of $6.50 to $7.00. With the stock trading near the support range and broad markets jittery, staying away from CLF makes sense.
Quarterly Results Unlikely to Boost Sentiments
The first point to note is that the company’s 2019 performance has been unimpressive. For the first nine months of 2019, Cleveland-Cliffs reported an 11% decline in revenue on a year-on-year basis to $1,358 million. For the same period, the company reported a 28.5% decline in adjusted EBITDA to $413.7 million. The decline in EBITDA margin was sharper due to weaker price realization from mining and pelletizing.
The 2019 performance discussion is to underscore the point that Cleveland-Cliffs is negatively impacted by weak steel prices in the United States. The Q4 2019 results are unlikely to spring any positive surprise and this is the first reason to remain bearish.
To elaborate, analyst estimates suggest 4Q19 revenue of $559 million, which will be lower by 19.72% on a YOY basis. Further, estimates point to earnings per share of 24 cents, lower by 56.36% on a YOY basis. Clearly, the markets don’t have a reason to cheer in the near-term and that’s being reflected in CLF stock price.
A second important point to note is that the weakness in the company’s numbers is due to the cyclicality factor. The steel industry has been relatively weak and that affects Cleveland-Cliffs. It seems certain that the coronavirus outbreak is likely to have a meaningful impact on the global economy. This can potentially extend the period of weak financial performance by the company.
Therefore, with CLF stock in a downtrend, investors can stay on the sidelines. Exposure can be considered after Q4 2019 results as an initial outlook (pro-forma for acquisition) for 2020 will provide more clarity on the valuation.
Positives Beyond Current Headwinds
While CLF stock might remain weak in the foreseeable future, investors can keep the stock in the buying radar. Post the acquisition of AK Steel, the company does look interesting with a potential to create value in the coming years.
The first point to note is that for the combined entity, the last-twelve-month free cash flow stands at $923 million. Therefore, even in relatively challenging conditions, the company will remain FCF positive and deleveraging is likely in the next few years.
The second important point to note is that 63% of AK Steel’s sales are to the automotive industry. North America light weight vehicle production is expected to decline from 16.8 million units in 2019 to 16.4 million units in 2020. However, beyond 2020, production is expected to gradually trend higher.
Cleveland-Cliffs is among the few steel producers capable of producing carbon and stainless steel grades for light vehicles. The industry trend beyond 2020 will therefore be positive for the company. In addition, with the consolidated entity being a vertically integrated steel manufacturer, margin expansion is likely.
My Final Thoughts on CLF Stock
For Q4 2019, Cleveland-Cliffs result is unlikely to cheer the markets. However, the focus will be on the initial guidance for 2020. The consolidated entity numbers might start to look attractive beyond 2020.
Therefore, if CLF stock does trend below $6.50, I see it as an attractive buying opportunity. Volumes growth, margin expansion and deleveraging are the likely triggers for upside. That’s after the markets digest the outlook for 2020 discounting the economic slowdown factor.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.