Analysis
The Investments of Ellis Wyatt
Dipping My Toe Again Into Cleveland-Cliffs
Oct. 29, 2018 12:55 PM•CLF
Summary
Cleveland-Cliffs has had a rocky decade.
Stability is here to stay at CLF.
Good leadership and improving financial condition are bullish.
CLF looks like a good investment going forward.
I will admit it, I have had a love-hate relationship with Cleveland-Cliffs (CLF) over the years. I made some good money off this stock, admittedly have lost good money on this stock, and have been trading it somewhat consistently since the financial crisis a decade ago. In nearly every year it has found some space in my portfolio, and I find it hard to kick the habit. It has mostly proved a value trap for me in the past, as I tried numerous times to catch the falling knife, and served up plenty of doses of heartbreak and false hope along the way.
I am still long CLF in a small way, but I wanted to look again at the stock and see if I (and all the interested readers) should be looking again at CLF given my fondness for finding early value, locating mis-priced market laggards, and my earnest commitment to basic materials investing over the long term.
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The Steel Sector And Basic Materials – The Tariff Story On Price Action
The steel and basic materials sector has not proven to be very lucrative in the last 6-month stretch. The initial euphoria of the tariff adjustments to the US market have proven to be over-hyped. The iShares US Basic Materials ETF (IYM) has moved from a high of $104.36 in June to the current price of $86.23 marking a drop of some 18% over the period. The Materials Select SPDR (XLB) and the Vanguard Materials ETF (VAW) have moved in a similar fashion, marking 6-month highs in June.
Moving out a little further, January has marked the zenith in many metals and mining stocks with the anticipation of the tariffs as indicated in IYM – it had sat at a high of $108.32 in January – and using this metric has dropped a full 20% from peak. XLB and VAW exhibit the same price action with peaks having been reached in January 2018 for the near term – around 21% drops from peak for each ETF.
Cleveland-Cliffs has actually been an exception in that 6-month time frame, having moved from $7.20 in May to $12.91 in September but it has recently settled lower closing Friday at $10.09. It looks even better in a 9-month time frame having come off a low of $6.48 in February. While CLF did see a surge in January, it took out that high in May and has moved mostly higher ever since. The last month has mostly been a consistent drop for the stock, moving off the highs and trending down to the current price during the correction we have seen throughout October.
The key to this picture on the intermediate market side is the tariff situation. This news story is now getting a little old in the tooth with the section 232 tariffs having gone into effect in March (Market Realist ), but the price action of basic materials and steel issues are largely being driven by the opinions and projections of the tariff situation as it moves into the future. Steel has grabbed all the headlines, but as a basic materials company with direct inputs to steel mfg. with domestic iron-ore we find that CLF is a direct a play on the domestic tariff situation as any steel producer.
While tariffs have indeed increased the spot price of steel during 2018, we also find some fear in the market that the tariffs are making other mfg. companies less competitive, steel companies less efficient, and only offering temporary succor. I can buy this picture somewhat, and it may prove that we have reached peak earnings for domestic steel producers this summer, but I believe the fear may be overblown.
The normalization of supply in China seems to be proceeding through lower production (China Steel at Peak, Set to Shrink in 2019: Top Ore Supplier ), and while some predictions of a global steel glut are being offered, we are seeing some M&A in the space particularly with MT picking up mills in Italy and now likely India (ArcelorMittal (NYSE:MT), Nippon Steel chosen as final bidders for India's...). This consolidation should prove healthy for the industry as it encourages responsible supply management.
Cleveland Cliffs – The Past Vs. The Future
Those who have been involved with this company for any amount of time should be familiar with the recent Cleveland Cliffs story. Those who haven’t, there is plenty out there to read. From its acquisition of Consolidated Thompson (Cliffs in C$4.9bn Consolidated Thompson deal) and its doomed project at Bloom Lake (Cliffs' overpriced acquisition of Consolidated Thompson comes back to haunt), we see a company that has not used its financial resources prudently or wisely in the last decade.
Those who bought CLF at the turn of the century and were lucky enough to hold until the financial crisis saw enormous gains. If you weren’t fortunate enough to have unloaded before the crisis hit but had the fortitude to stay the course until 2011, you would have been evenly rewarded again. That’s when the story changes for CLF from one of riches to one of rags, and the stock has largely done miserably ever since. The first insult was a complete cessation of the dividend over major debt issues in late 2014, and the second was a price drop to $1.38 in 2016, which represented a level not seen since the early 1990s for the company.
If you had gotten off the ride at the right times, you may have made some money on CLF, in some cases, serious money over a protracted time period. If you held consistently for 20 years, you wouldn’t have liked the outcome. Needless to say, the story of CLF is one that instructs caution for both company leadership as well as investors. Overall - the past is very mixed to be generous.
The Much Talked About Earnings Call
This is an interesting topic to evaluate CLF, both because it is very recent and has made headlines for the company. During a call on October 19th, the CEO Lourenco Goncalves spent some of his time ‘berating’ analysts he felt were not being accurate with the stock and the recovery story he has engineered (Cleveland-Cliffs CEO Goncalves berates analysts on conference call).
It is a bit unfortunate in that it made headlines in a not so positive way, and that it overshadowed the reinstatement of the dividend (Cleveland-Cliffs Restored Its Dividend, but Its CEO Got All the Headlines) (more on that later) but I believe it was a net positive for the company and for investors.
There are some details here that are surely important, but the big picture is I like this out of a CEO. He clearly is passionate about his business and its future, cares about how it is being represented on the Street, and is looking to improve the company going forward. This is the kind of guy I want in my corner as an investor. Should he have addressed the concerns differently? – perhaps. I think that this is a short-term news issue, and long term I see CLF leadership as passionate and looking to advance the ball and improve. Overall a positive.
The Dividend Is Back – Good Or Bad?
I love a good yield as much as anybody, and at one time CLF sported a nice juicy dividend. In 2012, it was paying $.63 quarterly to investors (including me) but could not continue at that rate for even one year, lowered the dividend to $.15 quarterly and suspended entirely going into 2015. During this time frame, it is important to note that the stock price went from a high of $100.39 to $6.62 at the end of 2014 all the while paying the dividend. This is clearly not positive or investor-friendly, and leaves a bad taste in many investors' mouths particularly those who are serious about dividend investing and capital preservation.
The dividend has now been reinstated as of the last earnings call, ex-div. Jan 3 and payable on Jan. 15th, at a much lower level than previous amounts currently representing $.05 quarterly or around 2% at today’s prices. This move has been a bit controversial for those of us with a history with CLF notably from the standpoint that the company had a history of returning cash to investors that it did not have, and massively cutting and moving away from its dividend. A dividend is great, but a dividend paid by debt is only robbing Peter to pay Paul. And boy, did CLF have a lot of debt. Now that CLF has gotten the debt load concern largely resolved, how do we view the return of the dividend?
My take here is that it is a positive development, especially in conjunction with Goncalves as the CEO. I do not view him as a leader that would reinstate the dividend if he felt that the FCF would not be stable and available well into the future. The now more reasonable debt load of $2.1 billion, sale of the Asia/Pacific iron ore operations for a one-time gain of $230 million, and current earnings per share of $2.74 certainly support this conclusion.
A trailing P/E of 3.68 and a forward P/E of 5.94 may paint too rosy a picture if earnings start to come down from a tariff hangover, but this dividend level is both cautious and prudent for a company that is newly re-formed and re-energized. Overall a positive.
Should A Long-Term Investor Be Looking At CLF As An Investment?
I am recommending that investors long CLF remain in those positions, mostly for the positive reasons outlined above and the likelihood that your cost basis is well below the current trading price. If you are a new investor to CLF please do your due diligence! This can be an interesting while albeit frustrating stock to trade at times, and the tariff situation is always evolving. I see the trajectory of the company at this point as positive, and the value seems right at or under $10.00 per share.
At this level, the stock now also yields 2% which is something to help you bide your time. I admit that I cannot project how this stock will move in the short term, but as a long-term trade, I believe it is moving higher. If you are interested in the steel and basic materials segment more specifically, there may be other opportunities that interest you – look to the steel space in Nucor (NYSE:NUE) and MT or look to large basic materials companies like BHP (NYSE:BHP) or Rio (NYSE:RIO) which are more diversified across different minerals and geographies. These companies may provide more protection to tariff-related issues given their global reach (Not NUE) and most are very efficient and proven operators in this space.
As a value investor who likes to trade on a long-term horizon, I like this stock right now, particularly at any price under $10.00 given the recent price action. I will keep it as an undersized portion of my portfolio in a half position, and allow time to prove whether my thesis on the company is correct to see if expanding the position is warranted. I had bought some additional shares at $10.90 but had found myself a little late on the move higher, too quick on the move lower, and now may find myself doing a little DCA as the stock becomes more attractive.
Note that there are analysts out there projecting a $5-6 target for the stock primarily due to oversupply in the market ( Cleveland-Cliffs heading to near $5 amid excessive supply, analyst warns). As always I recommend doing plenty of research, and setting a protective stop if there is a downdraft, but I think we will see $14-$15.00 with this stock in the not too distant future. Given the new dividend yield, CLF is now paying you a little to wait. To me, it’s a risk worth taking.
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Disclaimer: The opinions and the strategies contained herein are not intended to be official financial advice nor an official recommendation to buy or sell a security. Please evaluate each stock according to your own research and risk tolerance.
Disclosure: I am/we are long CLF.
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.
