Cleveland-Cliffs Stock Forecast

Sep 16, 2019

Originally posted on https://financhill.com/blog/investing/cleveland-cliffs-stick-forecast

Cleveland Cliffs Stock Forecast: Investing in iron ore mining is unique because the iron ore trades differently than other commodities.

What makes it unique is that most iron ore trades take place via contracts in which price changes are negotiated annually.

Because of this, when there is oversupply – such as thanks to the recent downturn in Chinese manufacturing – there is severe pressure on the price of iron ore. However, iron ore and, by extension, steel, will always be needed for manufacturing and infrastructure. That means that the companies who are involved in iron ore mining may not produce the large returns you might see in tech or the latest startup, but they can be a good investment.

Let’s take a closer look at an iron ore mining company – Cleveland-Cliffs [NYSE: CLF].

What Does Cleveland-Cliffs Do?

Cleveland-Cliffs [NYSE: CLF] is an iron ore mining company. It supplies the steel industry in North America with iron pellets that it collects from its mines and produces in its own plants.

The company expects to be the sole entity producing HBI (Hot Briquetted Iron) in the Great Lakes region. Previously, Cleveland-Cliffs served a larger area, but it has since become what it calls a “North America-centric business.” The change is significant enough that the company renamed and reorganized its segments. It discontinued its Asia Pacific and Canadian operations.

Now Cleveland-Cliffs’ operations are segmented based on the products it produces: Metallics and Mining and Pelletizing.

Cleveland-Cliffs [NYSE: CLF] is one of the leading companies producing iron ore in the United States. It has been concentrating on supplying companies in the Great Lakes region, but it recognizes that EAF steelmakers present a great opportunity. These steel companies produce steel products that carry a higher value than their alternatives and, as such, require different materials. Instead, EAF uses iron ore-based metallics like HBI.

In June 2017, Cleveland-Cliffs began construction on an HBI production plant, and it was nearly finished at the time the company’s 2018 annual report was published. Once completed, it will produce as much as 1.9 million metric tons of HBI per year.

The company expects its HBI production to supplant more than 3 million metric tons of its production of ore-based metallics and even more tons of scrap – another 20 million metric tons.

What’s more, Cleveland-Cliff’s new HBI plant is located close to almost two dozen EAFs. This important because freight costs can be significant in the steel industry and customers choosing Cleveland-Cliffs will be able to save on freight costs.

Is Cleveland-Cliffs Stock a Buy?

Cleveland-Cliffs [NYSE: CLF] went through some turbulence a few years ago. After the third largest shareholder in the company passed away, it triggered the forced selling of his entire position.

Since then, Cleveland-Cliffs has changed dramatically. Its balance sheet has turned around. The company reduced its long-term debt, even with its HBI plant investment and it has a better schedule for its debt maturity. Earnings are better and so are cash flows.

The company even started offering a dividend and increased it. Right now, it is at roughly 3% of the share price or $0.24 per year.

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That said, there is also a matter of innovation.

Keep in mind that Cleveland-Cliffs has been around for over 170 years. It was one of the first companies working in the Marquette Iron Range mines of Michigan and it was the first to add electrical power to its operations there. Chasing the HBI market is only the latest in Cleveland-Cliffs’ efforts to stay relevant.

What are the Risks of Buying Cleveland-Cliffs?

Cleveland-Cliffs [NYSE: CLF] does have some important risk factors.

One of the biggest is that its customers are highly-concentrated. In 2018, 57% of the company’s business came from ArcelorMittal, up from 48%

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in 2017. AK Steel contributed 25% in 2018 and 29% in 2017 while Algoma brought in 13% in 2018 and 11% in 2017. That is an extremely high concentration.

Losing one of those customers would be devastating.

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However, Cleveland-Cliffs does own a 21% stake in ArcelorMittal and it has an agreement with AK Steel to supply its Dearborn facility with pellets through 2022. These efforts do help secure Cleveland-Cliffs largest clients, but it is important for any investor to understand that there are still risks.

Environmental & Legal Risks

Cleveland-Cliffs also faces risk factors with regard to the environment and other legal concerns.

While the company is happy to take the steps it needs to comply with regulations, doing so comes with a steep price tag that cost $10 million in 2018 and will likely meet that figure in 2019.

Cleveland-Cliffs also has to manage regulations with regard to Minnesota’s Withdrawal of Proposed Amendments to the Sulfate Wild Rice Water Quality Standard.

There is also the matter of Conductivity.

Per Cleveland-Cliffs’ annual report, “Because the outcome of the Region 5 Petition is uncertain and the proposed Field-Based Methods for Developing Aquatic Life Criteria for Specific Conductivity is only draft guidance at this time, the exact nature and certainty of the potential risk to us cannot be predicted; however, direct application of the 320 μS/cm benchmark to our Minnesota-based assets may have a material adverse impact if the conductivity benchmark is applied to our NPDES permits.”

The company has to consider its groundwater connections as well.

If the Clean Water Act is expanded to include mine features like water retention facilities and on-site ditches, Cleveland-Cliffs will have to bear that burden and comply with the standards set forth at that time.

There are several other matters of this ilk that could shape the financial future of the company. Fortunately, Cleveland-Cliffs is aware of these potential costs and it has a strong enough balance sheet to bear the burden – probably.