Cleveland Cliffs 2025 Bonds Offer 6.5% Yield To Maturity

Summary

• Cliffs revenues have improved from 2016.
• Cliffs has a cash swell due to a share and debt issuance.
• Cliffs detailed financial guidance show the company has the cash flow to support debt reduction.

Cleveland Cliffs (NYSE:CLF) shares have seen pressure as investors are hesitating to see the benefits of steel tariffs. Besides the tariffs, the company has closed on two senior note offerings and published its 10-K since I last wrote about the company's fixed income opportunity three months ago. While the 2020 bonds have eclipsed par, their return is still 5.5% to maturity. Further down the maturity timeline, the company's 2025 bonds are priced at 96 cents on the dollar, yielding 6.5% to maturity when combined with the note's 5.75% coupon. Despite the recent price improvements, investors can still get solid return from Cliffs' bonds.

Source: FINRA

Cliffs' financial performance improved markedly in 2017. Revenues improved by more than 10% to $2.33 billion. The company's gross profit also improved to over half a billion dollars, which was more than twice the 2015 amount. The company's operating income saw a similar improvement. The only downside to the Cliff's profit and loss was the $165 million charge related to a loss of restructuring debt.

Source: SEC 10-K

Cliffs' balance sheet saw some dramatic changes in 2017. The company's cash balance increased by nearly $700 million to over $1 billion. This was in part due to the new debt issuances, however, the total long-term debt increased by only $130 million to $2.3 billion. Ultimately, the company's equity deficit improved noticeably from $1.33 billion to $444 million.

Source: SEC 10-K

The main reason behind the company's strong capital structure improvement is the $661 million in common stock issued during 2017. The common share issuance was in addition to $185 million in free cash flow generated during the year. These two activities were the leading influences to the company's cash balance swell.

Source: SEC 10-K

Another positive for Cliffs bondholders is the company's lack of secured debt. Secured debt can cut in line of unsecured creditors in the event of a bankruptcy, so having less secured debt makes the downside to unsecured creditors less. Additionally, the company has an unused $550 million asset backed liability facility that can be tapped into if cash flow turns negative. In terms of debt maturities, only $340 million of the $2.4 billion in debt comes due between now and the end of 2022. This gives Cliffs plenty of time to generate the capital necessary to further reduce debt.

Source: SEC 10-K

Fortunately for investors, Cliffs issued detailed 2018 financial guidance that can be used to determine the company's estimated cash flow. Based on the increased production guidance, I am assuming a dollar for dollar increase in revenue. Using the median cost of goods sold from the 2018 outlook, investors can estimate gross profit. Other costs and details can be drawn from either the guidance or the company's historical information

Source: Spreadsheet Combining Company Guidance and SEC 10-K

For cash flow purposes, investors should add the $100 million depreciation estimate to net income to get an operating cash flow estimate of $377 million. While free cash flow in 2018 is projected to be close to zero, this is due to the $250 million investment in the HBI project in Toledo and a $50 million mine upgrade. For the 2019-2021 estimates, NASDAQ earnings estimates, combined with normal capital expenditures provide some idea of where the organization is headed. The 2021 numbers assume no changes from 2020.

Source: NASDAQ

Source: Spreadsheet Combining Company Guidance and Earnings Estimates

In my opinion, Cleveland Cliffs should be able to generate nearly $500 million in cash flow that exceeds debt maturities over the next four years. By combining this with the current cash balance, Cliffs should be able to pay down $1.5 billion in additional debt by 2023. Bondholders should feel secure about Cliffs ability to deliver on its debt obligations.

CUSIP: U18618AD7

Price: 96.00

Coupon: 5.75%

Yield to Maturity: 6.5%

Maturity Date: 3/1/2025

Credit Rating (Moody's): B2

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I own Cleveland Cliffs 2020 bonds.