Cleveland-Cliffs (NYSE:CLF) is now not just an iron-ore producer but a vertically integrated steel producer. It produced a stellar second-quarter earnings report. As a result, CLF stock now has a good chance of rising to $31.28, up 31% from $23.91 as of Friday’s close.
The main reason I have to come to this conclusion is that Cleveland-Cliffs just reported its first quarter of free cash flow (FCF) in a little while. This is the main reason why the company will be able to lower its debt and increase its value over the next year.
Estimating Cleveland-Cliffs FCF
On July 22, the company announced its Q2 revenues of $5.045 billion, up from $1.093 billion a year earlier. Since then, the company acquired two steel producers and it is now the largest flat-rolled steel producer in the entirety of North America. Since CLF also produces its own iron ore, it was able to lower its steel-making costs quite significantly.
As a result, the company produced adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $1.36 billion in the quarter and $1.873 billion in the first six months of 2021. However, Cleveland-Cliffs produced $349 million in positive free cash flow (FCF) during Q2. This was the first time it has done this since September 2020, according to Seeking Alpha‘s page on the company’s cash flows.
This might be a little hard to see at first, given that the company did not specifically state its Q2 FCF performance. In fact, the six months Statement of Unaudited Condensed Consolidated Cash Flows shows that net cash provided by operating activities was just positive $132 million. And after deducting capex charges of $298 million, the six months FCF was actually negative $166 million.
So how can I say that the company made a positive $349 million in FCF? The answer is that this was the Q2 FCF performance.Q1 had a much higher negative FCF number, which can be seen in their Q1 earnings release. The difference with a much greater negative number (i.e., -$515 million) and a lower negative number (-$166 million) is positive $349 million. That means that Q2 had positive FCF.
Moreover, the $349 million in Q2 FCF represents 6.9% of the $5.045 billion in sales it made during the quarter. Analysts now project that the company will make $20.35 billion this year and $18.49 billion next year. So on average, its run rate revenue for the next 12 months will be $19.42 billion. If we multiply 6.9% to this number, the forecast FCF will be $1.34 billion over the next 12 months.
We can use that FCF estimate to value CLF stock.
What CLF Stock Is Worth
For example, if we use a 10% FCF yield to value CLF stock, its value works out to $13.4 billion. This represents a potential upside of 12.1% for the stock, putting it on a price of $26.80 per share, or 12.1% over its price today (Sept. 3) of $23.91 per share.
Moreover, given that the company could begin making positive FCF, the market is likely to give it a higher valuation with the FCF yield metric. That means the FCF yield number will be lower. So, for example, if we use a 7.5% FCF yield, Cleveland-Cliffs stock will have a value of $17.87 billion. That represents an upside of 49.55% or $35.76 per share.
So, on average we can estimate that CLF could be worth between $26.80 and $35.76 per share, or $31.28 per share. That represents an upside of 30.8% over today’s price of $23.91 (Sept. 3).
What Analysts Think
Analysts tend to agree with me. For example, Refinitiv‘s survey of eight analysts, as published by Yahoo! Finance, shows that their average 12-month price target is $29.59. Moreover, TipRanks.com indicates that six analysts who have written up CLF stock in the last three months have an average target of $30.89. This represents a potential upside of over 29% and is close to my target price of $31.28 per share.
The fact is the company is now producing significant amounts of free cash flow and it might not be completely apparent to investors. This is because its Cash Flow statement still shows negative free cash flow on a cumulative basis, given that Q1 had negative FCF.
Moreover, analysts are somewhat leery that the company will be able to obtain high prices as it did during Q2. For example, its price per net ton of steel averaged rose from $900 in Q1 to $1,118 in Q2.
However, even if prices decline a bit, the company might be able to sell larger amounts of steel. For example, even with higher prices, its total volume rose 1.5% from 4,144 net tons to 4,205 in Q2. In addition, CLF was also able to significantly increase its average EBITDA margin by lowering its costs. In Q1, its adjusted EBITDA margin was 12.67% and by Q2 it had jumped to 25.9%. This leaves plenty of room for the company to make profits even if prices fall.
What to Do With CLF Stock
So now might be a good time to take an initial stake in CLF stock, given that it has just turned FCF positive. Keep in mind that even if revenue falls over the next year, the stock could still rise as investors appreciate its powerful FCF performance.
In fact, I suspect that over the next year, FCF will turn positive for four quarters. That will likely raise CLF stock’s valuation to $31.28 per share, or 31% higher.
On the date of publication, Mark R. Hake did not hold any position, directly or indirectly, in any of the securities mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.