Aside from the occasional jump related to tariff or trade war news, there has been little reason for optimism on things such as Cleveland-Cliffs (NYSE:CLF) stock.
In fact, many investors probably haven’t thought about steel stocks in years. It certainly hasn’t been a glamorous sector.
At least until 2021, that is. The pandemic reopening trend has created opportunities in all sorts of stocks that had been left for dead. CLF stock is one such example.
Shares are up from $5 to $25 over the past 12 months, and it’s no wonder why. People are buying industrial goods such as automobiles, appliances and home furnishings at record rates. All of that stuff requires copious amounts of commodity inputs such as steel.
Meanwhile, the steel industry had been in a depressed state for years. Between a sluggish economy and heavy foreign competition, steelmakers rarely needed to produce at full blast.
Now, however, there are buyers as far as the eye can see. Still, though, bears are skeptical. They think that the demand for steel — like the inflationary wave more generally — will be transitory. So what are investors to make of suddenly red-hot CLF stock at this point?
A Closer Look at CLF Stock
The bull case for Cleveland-Cliffs is easy to figure out: The company is earning jaw-dropping profits right now. Analysts forecast that the company will earn more than $5 per share this year.
That puts the company at a tantalizing P/E ratio of 5.
This is tremendous earnings growth from previous years. Cleveland-Cliffs earned just over $1 per share in 2017 and 2019, along with pulling in $3.71 per share in 2018 at the height of the Trump administration’s trade wars and reflationary push. For Cleveland-Cliffs, 2021 is set to exceed even 2018’s profitability by a considerable degree.
If Cleveland-Cliffs could keep up earning $5 per share annually for the foreseeable future, CLF stock would be a screaming buy here. However, the problems start when trying to forecast future earnings.
Demand for things such as automobiles and appliances may remain elevated for a while, but it won’t last indefinitely.
To that end, analysts see Cleveland-Cliffs’ earnings falling to $3.17 in 2022 and just $1.99 per share in 2023. If the company earns $2/share in more average years, that would put the stock at 12x normalized earnings at today’s price.
That’s probably about fair for a highly volatile industry like steel. Don’t forget that Cleveland-Cliffs lost money outright in 2012, 2014, 2015, and 2020. For every outstanding year in the steel industry, there’s usually a pretty terrible one that will come not too long after.
The Longer-Term Outlook
There’s a lot of uncertainty as to how long Cleveland-Cliffs’ earning boom will last.
There are concerns around the durability of the current auto and home goods surge, of course, but there’s also the question of how profitable the enterprise will be in general as compared to its steel peers.
Cleveland-Cliffs has been on a major acquisition spree. It recently picked up both AK Steel and ArcelorMittal’s U.S. division. Prior to these mergers, Cleveland-Cliffs was more focused on the iron ore and pellet business.
These acquisitions couldn’t have come at a better time, as Cleveland-Cliffs has bulked up just ahead of an industry boom. Still, we’ll need to see how the company’s profitability and margins look once the current cycle peaks.
Cleveland-Cliffs’ long-term valuation will depend in large part on how its cost structure looks compared to other rivals such as U.S. Steel (NYSE:X) and Nucor (NYSE:NUE).
CLF Stock Verdict
Here’s the deal with Cleveland-Cliffs. It’s as if shareholders own a gold mine right now. For the foreseeable future, be it six months or a few years, the company will be printing money.
Everything is going as well as you could possibly hope for at the moment, but profit margins will rapidly retreat to normal and earnings will slump at some time not too far into the future.
The question is how to value these sorts of windfall short-term earnings. An astute trader can probably make money owning CLF stock here in the near term. There’s no indication that profits are about to plummet.
As such, owning a stock trading around five times earnings probably works as a quarter-to-quarter holding as long as earnings remain upbeat.
Be careful of any deterioration in profitability at all, however. The moment Cleveland-Cliffs’ earnings start to head south, the stock price will drop with it.
Cyclical stocks such as steel names are great to own during the boom. Just, whatever you do, don’t get caught holding them even a moment too late. The corrections tend to be brutal once the cycle peak hits.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.