John Carey, Portfolio Manager
September 24, 2018
Cleveland-Cliffs is the largest, U.S. independent iron ore miner and pellet producer that was founded in 1847. The stock sold off from an all-time high of just under $100 in 2011 to under $2 per share in 2016 as huge missteps by the company and a major decline in global iron ore prices had it heading towards bankruptcy. Lourenco Goncalves, an experienced steel industry senior executive, came out of retirement to win a proxy fight and become the CEO in 2014. Goncalves moved quickly to sell unprofitable assets, significantly pay down debt, sign multi-year supply contracts with domestic steel manufacturers and focus Cliffs on its original and most profitable business exclusively in the United States.
Given the current economic cycle, we believe Cleveland Cliffs is well positioned for the following reasons:
Regardless of whether the U.S. legislature passes a major infrastructure bill or not, all you need to do is drive around any major city to see the amount of improvement and repair work being made to highways, buildings and bridges. Tariffs on foreign steel producers also provide an added benefit for Cleveland Cliffs.
From a business standpoint, the high-quality iron ore that Cliffs mines in the Great Lakes region currently generates EBITDA margins of over 40%.*
Cliff’s current market cap is $3.6 billion. The company projects $400 million of free cash flow in the second half of this year and $800 million in 2019.*
The company is building the first Hot Briquetted Ingot (HBI) plant in the U.S. HBIs are expected to be used more and more in electric arc steel manufacturing furnaces because they are more profitable and environmentally friendly than current iron ore pellets. The plant is fully funded and with its estimated start up in mid-2020, Cliffs’ EBITDA margin is projected to exceed 50%.*
Net debt to trailing EBITDA has declined from 5X at year-end 2016 to 2.5X at year-end 2017 and an estimated 1.2X for year-end 2018.**
In our opinion, Cliffs’ management is clearly in the driver’s seat here. The stage is set for them to generate ongoing sales, earnings and free cash flow growth over the next several years, while continuing to reduce its debt outstanding and enhancing shareholder value via stock buybacks and/or cash dividends. Stay tuned.
* Value Line - September 7, 2018
**CRFA (S&P Global) - September 15, 2018