Strong Demand Makes Cleveland-Cliffs an Undervalued Mid-Cap

Cleveland-Cliffs NYSE: CLF beat on the top and bottom lines when it reported first quarter earnings on Tuesday, April 25. Analysts have been lukewarm about CLF stock with a consensus Hold rating. And the day before earnings, both Citigroup Inc NYSE: C and Bank of America NYSE: BAC reaffirmed their Hold ratings on the stock. But strong demand from the company’s most important sector may give investors a reason to take a closer look.  

Before the market opened, Cleveland-Cliffs reported negative earnings per share of 11 cents. That beat estimates for negative earnings per share of 13 cents per share. At the end of March, the company had forecast $5.30 billion in revenue and the report came in right at the number which was above analysts’ expectations for $5.21 billion.  

Reversing the Trend 

The earnings beat reversed a trend of five consecutive quarters of slumping earnings. It also broke a streak of two consecutive quarters of declining revenue. Both numbers, however, were lower than in the same quarter the prior year. That may be one reason CLF stock gave up most of its prior gains even after the earnings beat. 

This may be an overreaction. The company reported direct sales to the automotive sector increased to 36% of sales. Management forecasts sales volumes to this sector to remain strong throughout the year. The company will also benefit from its recent contract negotiations with each of its automotive clients, which resulted in a higher price for the steel the company provides. 

The strong demand had the additional benefit of allowing the company to increase the spot market base prices for all of its hot-rolled, cold rolled and coated steel products by at least $100 per net ton. This new price increase, which took effect in early April puts the minimum base price for the company’s hot-rolled steel at $1,300 per ton.  

The company’s ability to raise prices is a confirmation of remarks made by United States Steel Corp. NYSE: X. The company said it was forecasting steel prices to rise in 2023.  

A Roller Coaster Ride  

CLF stock has been a volatile choice for investors in the past 12 months. The stock is down 43% in the last 12 months and it’s down 28% since the beginning of March. However, the stock is essentially flat for the year, so your gain or loss really depends on when you bought the stock.  

But after earnings, the question is not where has the stock gone but where is it going?  

According to the company’s chief executive officer (CEO) Lourenco Goncalves the rest of the year looks bright. The company has successfully renewed all its automotive contracts which, according to Goncalves, will lead to strong EBITDA growth for the rest of the year. Plus the across-the-board price increases will lead to “another year of great cash flow generation.”  

The company also recently agreed to a 12-year extension of its existing contract with SunCoke Energy, Inc. NYSE: SXC in which Cliffs will receive 1.22 million tons of metallurgical coke annually 

Is CLF Stock a Buy? 

The risks for Cleveland-Cliffs stock are the same today as they have been for the past year. The company is reliant on the automotive sector. While it appears that many companies have the capacity to increase production, it’s unclear of how deep or long-lasting a recession will be. Higher prices for steel won’t be as impactful if demand slows. This is particularly an issue for Cliffs since automotive is its largest sector. 

Then there’s the company’s debt. The company did announce pricing of $750 million in senior unsecured guaranteed notes that have a maturity date of 2030. The company intends to use the net proceeds to repay some of the company’s debt under its existing asset-based revolving credit facility. It’s also pledging to reduce its pre-payable or callable debt of over $2 billion through its expected free cash flow generation.  

While this does extend the company’s debt profile, borrowing to pay down debt is a risky strategy. And that debt will continue to be an overhang on the stock should the economy continue to weaken.  

Still, CLF stock is trading at 6.2x earnings. And Cleveland Cliffs analyst rankings show that the stock may have a 40% upside. Without a dividend in place, however, that may not be enough to attract investors at the current price.  

The stock is currently around a support level of $15.35. If CLF stock fails to hit support, the lows of December 2022 could be in play. At that point, the stock would carry less risk for investors.