Recently I took my own advice and bought stock in Cleveland-Cliffs (NYSE:CLF). The iron and steel maker had already made an impressive run when I finally got in, near $20 a share. Then I bought a little more, near the Aug. 24 opening price of $24 per share of CLF stock.
Cleveland-Cliffs is due to be a big beneficiary from the bipartisan $3.5 trillion infrastructure bill moving through Congress. Steel is also going to be needed for electric cars. That steel won’t be coming from China because a big part of Biden’s plan involves boosting domestic producers.
You can call it a risky call and I hope you will. When everyone is in on a stock it’s due for a fall.
Goncalves’ Plan
CEO Lourenco Goncalves, a native of Brazil, showed exquisite timing when he put the current company together, buying AK Steel and Arcelor-Mittal works last year.
The second quarter report delivered $780 million of net income, $1.33 per share, on revenue of $5 billion. Based on those results, the market capitalization of $11.8 billion still looks cheap.
Goncalves took on over $5 billion of debt putting the assets together and knows precisely what he wants to do with current gains. “We are set for a monumental debt reduction during the back half of this year, and the achievement of zero net debt in 2022,” he told shareholders last month. When interest rates start rising next year, Goncalves won’t be paying them.
Last month, the company redeemed about $1.2 billion of preferred stock, which bolstered the capital structure, reducing the diluted CLF share count by 10%. ” The buyback is done, and the total cash spent is less than the free cash flow we expect to generate this quarter,” Goncalves told shareholders. Smart.
Cleveland-Cliffs is Old Timey
Cleveland-Cliffs is a basic, old-time steel maker, more like United States Steel (NYSE:X) than Nucor (NYSE:NUE).
It brings iron pellets down the Great Lakes to Ohio. It uses coal, in the form of coke, rather than electric arc furnaces that would pollute less. New investment, $100 million worth, is going into reducing that environmental cost.
One cost that will be harder to control is labor. Cleveland-Cliffs is a union shop. The company is currently at peace with its unions, and Goncalves hopes cash will get the workers vaccinated against COVID-19.
Goncalves’ success, so far, has attracted politicians like flowers attract bees.. It has also brought patriotic Reddit traders to the name. The wind is at its back.
Can It Last?
The question for investors is how long the good times might last.
Steel is about as a cyclical a business as you can get. China dominates the market. All of America’s production represents just one-tenth that of China. In 2017 China was a net exporter of steel, North America a net importer. The Trump Administration’s reaction was to impose tariffs on imported steel. The Biden Administration has not repealed them.
Goncalves is depending on the U.S. market remaining both robust and patriotic. When the debt is added to the equity, Cleveland-Cliffs has an “enterprise value” of $17.5 billion. Paying down the debt moves all that value to equity, even if there’s no improvement in business.
There remain risks. Tariff peace might break out, especially with the European Union. Demand could weaken, lowering prices. The infrastructure plan may blow up. Those seem like minimal risks over the next year.
The Bottom Line
Even after current debts are paid, Cleveland-Cliffs will need continued investment. It needs to keep reducing pollution, even after cutting it by 19% last year with carbon capture technology.
The biggest risk may be Nucor, whose electric arc furnaces and use of recycled steel deliver product at very low cost. Since the start of the year Nucor stock has outperformed that of Cleveland-Cliffs, almost twice the gain. Nucor now has three times the market cap of Cleveland-Cliffs.
But if debt can be eliminated, and if Cleveland-Cliffs can pay a dividend, that momentum could reverse, at least for a time. And your investment will have put the U.S. steel industry back on its feet. Your profit when you sell, maybe in late 2022 to a yield-oriented investor, will feel earned.
On the date of publication, Dana Blankenhorn held long positions in CLF. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Living With Moore’s Law: Past, Present and Future available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or tweet him at @danablankenhorn. He writes a Substack newsletter, Facing the Future, which covers technology, markets, and politics.
