Cleveland-Cliffs: Still Undervalued, Under-Owned, And Unloved

Jul. 26, 2021 2:29 PM ETCleveland-Cliffs Inc. (CLF)AMSYF, MT, NUE, STLD, X125 Comments


  • Cleveland-Cliffs' stock price has performed very well over the past year.
  • Cleveland-Cliffs' underlying business has performed even better, and the forthcoming free cash flows are transforming the balance sheet.
  • The end result is that shares are still undervalued today, with envious upside potential, especially compared on a relative basis to the prospective broader market equity returns.
  • This idea was discussed in more depth with members of my private investing community, The Contrarian. Learn More »
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Try to buy assets at a discount rather than earnings. Earnings can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings."

- Walter Schloss

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."

- Sir John Templeton

Life and investing are long ballgames."

- Julian Robertson


On April 21st, 2021, I penned an article on Cleveland-Cliffs (NYSE:CLF), which was titled "Cleveland-Cliffs: Estimates And Expectations Still Too Low", and the summary bullet points from that article illustrate the prospective headline playing out in real time over the past three months.

Cleveland-Cliffs(Source: Author's April 21st Cleveland-Cliffs SA Article)

Building on the narrative above, earnings estimates and expectations were indeed too low, with 2021 earnings estimates rising to $5.74 as I write this article, up from $3.40 in the April 21st, 2021 authored article above. Additionally, 2021 EBITDA estimates have risen from the upwardly revised guidance of $3.5 billion from the April 21st, 2021 update, to $5.5 billion today following the release of CLF's second quarter 2021 earnings.

Cleveland-Cliffs' share price has responded, gaining 26.6% versus a 5.7% gain in the S&P 500 Index (SP500) since the April 21st, 2021's article publication, however, there is more upside in store for CLF shares as market participants digest the enormity of Cleveland-Cliffs' free cash flows, specifically over the next six calendar quarters, which will further transform the balance sheet.

The end result of these free cash flows is that Cleveland-Cliffs will be debt free by the end of 2022, inclusive of buying back a large chunk of stock along the way, either via the retirement of the ArcelorMittal (MT) preferred shares, or through an outright common stock buyback, or both. The forthcoming balance sheet moves will raise the bar on the baseline earnings power and free cash flow generation for Cleveland-Cliffs, which will engender another round of credit and analyst upgrades.

Earnings Estimates Then and Now

Looking back to the April 21st, 2021 article cited above, earnings estimates for Cleveland-Cliffs were already in an uptrend.

Cleveland-Cliffs Earnings Estimates

(Source: Author's April 21st, 2021 SA Article, Yahoo Finance)

Fast forward three months, and CLF's earnings estimates have risen more substantially, both in 2021, and even more importantly, in 2022.

Cleveland-Cliffs EPS Estimates(Source: Yahoo Finance)

The increases in earnings estimates above are being driven by higher-than-expected steel prices, which now extend out past December of 2022, with 2021 steel prices exceeding all expectations only three months ago, and these headline earnings are flowing through to EBITDA numbers, and more importantly, to free cash flow generation.

Free Cash Flow Generation, Potential Share Buybacks, & A Debt Free Balance Sheet

On the Q2, 2021 earnings call, with the transcript published on Seeking Alpha, CFO Keith Koci highlighted the impressive free cash flow generation that is happening now, and what that means for Cleveland-Cliffs' balance sheet going forward (emphasis added via bold text is mine).

Keith Koci

Our free cash flow generation will certainly be further increased in the third quarter. We expect to generate $1.4 billion in cash from our expected $1.8 billion in adjusted EBITDA for the third quarter. These numbers result from continued rise in prices on our HRC linked contracts and spot sales, offset by higher employee-related costs and the planned outage at our largest blast furnace Indiana Harbor Number 7. Furthermore, we are increasing our full year adjusted EBITDA guidance to $5.5 billion.

Our free cash flow expectation still includes minimal federal cash tax disbursement as a result of our NOL position. Given our immense profitability so far this year, we have been able to effectively utilize our sizable NOL balance, and we'll continue to utilize it for the rest of the year. With these NOLs rapidly being used, we expect to become a federal cash taxpayer again at some point either later this year or early next year.

Our main priority with this free cash flow continues to be the pay down of debt. The level of free cash flow we are expecting has created a generational opportunity to completely de-risk our balance sheet, and we are taking full advantage.

In the second quarter, we made open market bond repurchases and completely redeemed the remaining $400 million of our 2025 unsecured notes, the only bond we had that was callable this year. Our debt-to-cap ratio is currently at a nine-year low, and we have already repaid another $455 million in debt during just the first 20 days of July. As the year progresses and into next year, we will be rapidly and methodically reducing our debt balance, and we expect to reach net debt zero sometime next year.

As shown above, the generational balance sheet transformation is happening in real time, and for many analysts who have correctly touted the superior balance sheets of Nucor (NUE) and Steel Dynamics (STLD), which have also been strong equity performers, versus those of their more indebted peers, Cleveland-Cliffs and U.S. Steel (X), there is a changing of the guard taking place.

CEO Lourenco Goncalves highlighted the impressive free cash flow generation, and added a wrinkle in an exchange with B. Riley analyst Lucas Pipes, suggesting CLF's could use one calendar quarter of the company's free cash flow generation to eliminate the ArcelorMittal's preferred shares, further improving CLF's balance sheet, and eventual share count, with another opportunistic, accretive transaction (again, emphasis added is mine).

Lourenco Goncalves

So take a reality as the backdrop net debt zero is always a good thing if you can accomplish that. We are having an opportunity of a lifetime to accomplish that. That's why net debt zero is our goal.

This being said, we are always open to other things. I'll give you an example, Lucas. Due to the stock price performance during the last several days, I am now considering a full redemption of the ArcelorMittal preferred for cash. I have never done that before. I have never thought about that. But when I realized that the market is skeptical about a lot of things that I know that the market is wrong, and I know about the cash flow that's coming the $1.4 billion in cash coming in Q3 is real, the way our prices are -- our pricing structure is construed, as well as the Q4, another $1.8 billion. So I know the cash that's coming in. I can use that cash. And based on the way that calculation is made, it will be a good thing for us. It will be a good thing for ArcelorMittal.

So I'm not saying I'm going to do it, but I'm considering redeeming the preferred in cash at this point. So don't feel like a net debt zero is what we are going to accomplish no matter what and ignoring all the rest. It's just a reasonable goal to accomplish, coming from a company that has been reasonable all the way. Sorry for the long answer.

By eliminating the ArcelorMittal preferred with cash, Cleveland-Cliffs would be eliminating a preferred overhang, effectively retiring an equivalent of roughly 50 million common shares given the current share price and the volume weighted average pricing redemption. From my perspective, this appears to be a discounted price given the balance sheet transformation at Cleveland Cliffs, and the in-process revaluation of shares higher.

Steel Prices Then and Now

In my April 21st, 2021 article, I had a chart showing steel prices from my March 3rd, 2021 article, "The Current Version Of Cleveland-Cliffs Is Lourenco Goncalves' Defining Masterpiece," and from my April 21, 2021 article, via SteelBenchmarker.

Steel Price

(Source: SteelBenchmarker, Author's March 3rd, 2021 SA Article)

(Source: SteelBenchmarker, Author's April 21st, 2021 SA Article)

The progression of steel prices from February, March, and April of 2021 has continued, with new high prices in the U.S., and rising prices in Europe, China, and the rest of the world too.

Rising steel prices(Source: SteelBenchmarker)

Looking at the charts above, there are dual surprises, both with the heights that steel prices have reached, and the duration that steel prices have maintained these lofty heights. Remember, many analysts predicted the top in steel prices was happening in the first quarter of 2021, and now steel prices extend at what were unthinkable prices in the first quarter of 2021 all the way through December 2022 futures.

Obviously, this can change, however, even if steel prices turned down today, the balance sheet transformation at Cleveland-Cliffs and U.S. Steel has already been far superior to what many imagined possible a scant six months ago.

Closing Thoughts: Valuation, Looking Forward Versus Not Looking Backwards

Clearly, the paradigm is changing with Cleveland-Cliffs, the U.S. steel industry, and the global steel market. Given the dynamic change that is taking place, naturally, analysts are scrambling to adjust their estimates and figure out what is the new normal going forward. During this process of transition, it is a time of great opportunity, as the past intermingles with the future.

Specific to Cleveland-Cliffs, the enterprise value at Friday's close was roughly $16 billion, and we saw in the conference call commentary that Goncalves is targeting $1.4 billion in free cash flow generation in Q3 of 2021, and $1.8 billion in Q4 of 2021.

Annualizing this, we arrive at a $6.4 billion free cash flow number, which is implying a FCF to EV ratio of 40%, which compares very favorably to a tech titan like Apple (AAPL), which sports roughly a 3% free cash flow yield to enterprise value right now.

Obviously, market participants collectively view Apple's free cash flows as a near certainty as far as the eye can see, even though I would argue that the risks for the broader U.S. equity market are extraordinarily high today. Adding to the relative valuation argument, Apple's relatively paltry free cash flow yields are subject to interest rate risk, as longer duration bond yields increase, and the yield spread becomes competitive between longer duration bonds and the markets longest duration assets, which are the large-cap technology mega-capitalization companies.

At the opposite end of the spectrum, market participants collectively view Cleveland-Cliffs surging free cash flow yields as temporary. This may be true, however, by the end of the next year, Cleveland-Cliffs' debt will be entirely removed, and even if you assume a normalization of steel prices, it is not hard to envision a 10%, 15%, or 20% sustainable free cash flow yield for CLF shares.

Further adding to the attractive absolute and relative valuation narrative, is the fact that the current pessimism and skepticism regarding the longer-term price deck for steel prices, is amplifying the capital cycle because new additional incremental capacity is not being brought online, even with the all-time steel price highs.

(Source: GMO)

Looking at the graphic above, we are not at the elevated valuation stage yet, hence the lack of new supply coming online.

What would it take to get to the elevated valuation stage?

Even assuming FCF's retreat from the annualized $6.4 billion number to $3 billion, or even $1.5 billion annually, it is relatively easy to get to a doubling of Cleveland-Cliffs' stock price from current levels, which would be a share price in the $40’s today. This will become achievable as the belief of durability of free cash flows is strengthened, which will happen as the longer the burgeoning secular upturn continues. Bigger picture, we have to remember that we are closer to the beginning of a secular upturn in the downtrodden commodity equities over the past decade, rather than the end.

Cleveland-Cliffs Valuation(Source: Author,

Commodity Supercycle

(Source: Longview Economics, Macrobond)

In closing, for much of the past two years, even though the market bottom in March of 2020, I have been pounding the table on the extremely out-of-favor commodity equities, and I still think we're in the early innings of what will be a longer-term price appreciation. Investors skittish of the commodity sector should research cast aside financials as they also will benefit from rising inflationary expectations and rising long-term interest rates. Understanding the bigger picture, then having an understanding of the bottoms-up fundamentals has been the key to outperformance, and this is a path that has not been easy with those participating confirming this reality. However, the road less taken is sometimes the better one, and I firmly believe that today, as traditional stocks, bonds, and real estate offer very poor starting valuations and very poor projected future real returns from today's price levels. More specifically, the out-of-favor assets and asset classes, including commodities and commodity equities and out-of-favor specific securities are where the historic opportunity has been, and that's where it still stands, from my perspective.

The Contrarian

There is historic opportunity in the investment markets today.  I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past.  From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009.  For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.

This article was written by

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Author of The Contrarian
"Against the grain" investing backed by real-world wisdom and experience
Founder of "The Contrarian", a premium research service, featuring a committed, collegial group that has uncovered a number of hidden gems, hidden in plain sight.  Immensely proud of what our members have accomplished.  Actively investing since 1995, I have soared like an eagle, and been unmercifully humbled by the markets. Achieved positive returns in 2008, and turned an account with $60,310 on 1/1/2009 into an account with $3,177,937 on 11/30/2009. My best years have been 1995-2003, 2008-2012, 2016, 2020, & 2021. My worst years were 2013-2015 & 2017-2019. I believe inflation is coming, and we are at an inflection point in the markets.

Twenty plus year career as an investment analyst, investor, portfolio manager, consultant, and writer. Founder of Koldus Contrarian Investments, Ltd, which was incorporated in the spring of 2009. Dyed in the wool contrarian investor, who has learned, the hard way, that a good contrarian is only contrarian 20% of the time, but being right at key inflection points is the key to meaningful wealth creation in the markets. I believe we are near a meaningful inflection point, perhaps the biggest one yet, for the third time in the past 15 years.

Historically, I have had huge wins and impressive losses based on a concentrated, contrarian strategy. Trying to keep the good while filtering out the bad.

Seeking to run an all weather portfolio with minimal volatility and index overlays to capture my strategic and tactical recommendations along with a concentrated best ideas portfolio, which is my bread and butter, but the volatility only makes it suitable for a small piece of an investor's overall portfolio. The following are a couple of my favorite investment quotes.

"Life and investing are long ballgames." Julian Robertson

"A diamond is a chunk of coal that is made good under pressure."

Henry Kissinger

"Knowledge is limited. Imagination encircles the world." Albert Einstein

I’ve been on top of the world, and the world has been on top of me. I have learned to enjoy the perspective from each view, and use opportunities to persistently acquire knowledge, and enjoy the company of those around me, especially loved ones, family, and friends.

At heart, I am a market historian with an unrivaled passion for the capital markets. I have had a long history and specialization with concentrated positions and options trading. Made money in 2008 with a net long portfolio, deploying capital in some of the market's darkest hours into long positions including purchases of American Express, Atlas Energy, Crosstex, First Industrial Real Estate, General Growth Properties, Genworth, Macquarie Infrastructure, Ruth Chris Steakhouse, and Vornado near their lows. Shorting, hedging, and option strategies also helped me in 2007 and 2009, and these are skills that I have developed ever since I started trading heavily in 1996.I enjoy reading, accumulating knowledge, and putting this knowledge to work in the active capital markets, learning lessons along the way.To this day, I continue to learn, and some of these learning lessons have been excruciatingly difficult ones, especially over the past several years, as I made mistakes allocating capital, including a sizable portion of my own capital (I always invest alongside my clients), to commodity related stocks. While all commodity related stocks have struggled since April of 2011, coal companies, which attracted me due to their extremely cheap valuations, and out-of-favor status (I am a strong believer in behavioral finance alongside fundamentals and technicals) have been the worst investing mistake of my career. The focus on the commodity arena has been the biggest mistake of my investment career thus far, yet in its aftermath, I see tremendous opportunity, even larger in scope than the fortuitous 2008/2009 environment.The capital that I accumulated and the confidence gained in navigating the treacherous investment waters of 2008 gave me the confidence to launch my own investment firm in the spring of 2009, right before the ultimate lows in the stock market. At the time I was working as a senior analyst at one of the largest RIA's in the country, and I felt strongly that the market environment was the best time since 1974/1975 to start an investment firm.

Prior to starting my firm, I was a senior analyst for three different firms over approximately 10 years (Charles Schwab, Redwood, Oxford), moving up in responsibility and scope at each stop along my journey. Since I was a paperboy, I have always had an interest in the investment markets. I love researching and finding opportunities. I was a Chartered Financial Analyst, CFA from 2006-2018. Additionally, I have been a Chartered Alternative Investment Analyst, CAIA. After starting in the teaching program at Ball State University, I switched to a career in finance when I turned a small student loan into a substantial amount of capital. I graduated summa cum laude with a degree in finance from Ball State.

Full disclosure, I am not currently a registered investment advisor, though I did serve in this capacity from 2009-2014, while owning Koldus Contrarian Investments, Ltd. Additionally, I held various securities licenses from 2000-2014 without a single formal complaint filed. At the end of 2014, I voluntarily let my state registration expire, as I transitioned the business to a different structure after going through a brutal business environment, divestiture and difficult divorce and custody battle. Prior to this, I had passed, and held, various securities exams and licenses, including the Series 7, Series 63, and Series 65 exams, in addition to others, alongside the CFA and CAIA designations. Unfortunately, I did not file the proper paperwork to withdraw my state registration, and I did not disclose a personal arrangement, and subsequent civil case, between myself and a former close personal friend and client. This arrangement was initiated informally in 2011, after a substantial period of success, as we aimed to be business partners, and it ultimately resulted in a dispute. I was unaware that I was required to disclose these items, and my securities attorney, at the time, did not advise me to do so. Previously, I had managed a portfolio for this gentleman, and we had taken an investment of approximately $7 million in 2009, and grown it to over $25 million at the beginning of 2012. After a very difficult year of performance, an employee of the firm I owned, and friend, resigned in early 2013, and took the aforementioned client to a competing firm. As a result of not filing the proper paperwork, I agreed to a settlement, with a potential $2500 fine in the future, depending on if I choose to reapply to be a non-exempt advisor. Additionally, while going through the difficult divorce and business dispute and divestiture, I did not file the proper disclosure on two of the annual CFA renewals. As a result, the CFA Institute sought a 3-Year Suspension of my right to use the CFA designation, which I appealed, since the primary investigator in the case sought a 1-year suspension of my right to use the CFA designation for a majority of the investigation. A Hearing Panel heard the case, and went against the recommendation of the CFA's Institute's Professional Conduct Department. Long story short, be careful who you trust, especially when substantial money is involved, and always disclose everything properly, which is hard to do when you are going through difficult situations, as this is the last thing you are probably thinking of at the time. In closing, I have had more experience in the markets, business, and life than most, yet I am grateful & thankful for every day. Additionally, I have learned through success and failures that you have to move forward, and if you can do this, your life will form a rich tapestry of stories.

Disclosure: I/we have a beneficial long position in the shares of CLF, X, AND AM SHORT AAPL AND SPY either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Every investor's situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication and are subject to change without notice.

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