Cleveland-Cliffs Needs to Fix its Fundamentals to Maintain Momentum

Cleveland-Cliffs Inc. (NYSE:CLF) is an iron ore mining company and steelmaker whose shares are performing extremely well in 2021. Investors have enjoyed year-to-date gains of about 61%, and a one-year performance of 257%. This momentum makes CLF stock interesting to watch. But whereas many analysts see a bargain opportunity, I see notable risks that make me too skeptical.

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If stock market history has taught us anything, it is that market conditions can change quickly and unpredictably. Cleveland-Cliffs is now facing favorable events such as the large infrastructure bill that has been passed by the U.S. Senate, but there are also unfavorable risks such as an economic slowdown in the Chinese economy.

You just have to look at factors that are crucial in both the micro and macroeconomic environment.

China’s Economic Slowdown: A Big Threat for Cleveland-Cliffs

Cleveland-Cliffs is not just another iron ore mining and steelmaker company. On its official website it states “Cleveland-Cliffs is the largest flat‑rolled steel producer in North America. Following the acquisitions of ArcelorMittal USA and AK Steel, and the completion of our Toledo Direct Reduction plant in 2020, Cleveland-Cliffs is a different company. We are a vertically integrated high-value steel enterprise.”

I see both advantages and disadvantages in this vertical integration. But first, a quick note on the macroeconomic level. News that iron-ore prices tanked due to China’s slowing steel output is negative for Cleveland-Cliffs, as iron-ore is essential for the production of steel. China is one of the largest iron ore players and a recent report by Deloitte mentioned that “Indicators point to a deceleration of China’s economy.”

Both retail sales and industrial production slowed down in China. This could hurt the profitability of Cleveland-Cliffs if global steel demand also witnesses a slowdown.

The Federal Reserve is gradually moving closer to tapering, with increasing interest rates to fight inflationary pressures. Higher interest rates for a company with a substantial debt level such as Cleveland-Cliffs is a problem.

What about this vertical integration and the restructuring strategy? Is it good, or bad?

There are many advantages, such as no reliance on outside suppliers, plus economies of scale and the ability to pass any savings on to customers.

But at the same time, there are important disadvantages to consider, including the high capital expenditures needed to set it up. Other notable disadvantages are a reduction in the company’s flexibility to make business decisions and even a loss of focus.

Overall this vertical integration that Cleveland-Cliffs chose to follow should be monitored and evaluated in the coming quarters and years.

Second-Quarter 2021 Results: Something to Be Excited For

Cleveland- Cliffs reported Q2 2021 results that were very strong. They reported $5 billion in revenue and $795 million in income, with adjusted EBITDA of $1.4 billion — a record for the company.

If we compare the same quarter for the past year to avoid any seasonality, then the news was very good. “In the prior-year second quarter, the Company recorded a net loss of $108 million, or a loss of $0.31 per diluted share.”

However, I have some important concerns about Cleveland-Cliffs and its financials.

Balance Sheet: Too Much Debt

A debt of almost $5.4 billion at the end of June 2021 may or may not mean much to a company. It depends on the total debt level, on the cash balance and on the free cash flows to repay this debt.

Cleveland-Cliffs mentioned on its Q2 2021 report that “As of July 19, 2021, the Company had total liquidity of approximately $2.1 billion.” Gurufocus reports that the current D/E ratio for Cleveland-Cliffs is 1.66 and that it has an Altman Z-score of 1.57, which puts it into the distress zone.

The free cash flow trend is also not inspiring for the past five years. The last year reported with a positive free cash flow of $182.4 million according to MarketWatch was in 2018. In 2019 free cash flow was (93.5 million) and in 2020 (786 million).

Valuation: Not a Bargain

In 2020 Cleveland-Cliffs issued 506.832,537 shares to fund its acquisitions. A highly dilutive strategy that is not good for CLF stock valuation. According to MorningStar, book value per share has improved as of 2018, when it was reported to be ($0.29) to $1.70 per share in 2020 and $6.47 on a TTM basis. A closing price of $24.37 on Aug. 27 2021 indicates a TTM Price-to-Book Value per share ratio of 3.76x which is far from being considered to my analysis a bargain.

CLF Stock: A Lot Needs to be Done

The management is trying to reduce the debt level. This is very good.  But I anticipate increasing capital expenditures that probably will result in weak free cash flows unless a big and sustainable surge in profitability occurs. Last fiscal year’s report that showed revenues growing 169.06 % in FY 2020 to $5.35 billion and net income falling 141.67 % to -$122.00 million, are of high concern.

I do not see yet the strong sales growth to translate to net profitability. Therefore I remain skeptical on CLF stock for now.

On the date of publication, Stavros Georgiadis, CFA  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 Publishing Guidelines.

Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.   

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