Cleveland-Cliffs Will Get Hit By Lower Auto Demand, But Liquidity Should Help It Weather The Storm
Apr. 06, 2020 3:28 PM ETCleveland-Cliffs Inc. (CLF)6 Comments
Summary
Cleveland-Cliffs shares stabilize after a major downside move as the market hopes for the re-start of the economy after April.
The potential infrastructure bill is another positive catalyst, but it remains to be seen whether anything will be done this year.
Risks remain as the U.S. enters into a recession and the automotive demand is hit hard.
The situation has changed materially since I last wrote about Cleveland-Cliffs (CLF). The company has completed the acquisition of AK Steel and got immediately hurt by the coronavirus crisis. While the operations are largely unaffected since the steel industry is an essential business, the construction of the HBI project had to be shut down due to virus containment measures. More importantly, the company will be facing a blow from the real-life hit to steel demand as the U.S. economy heads into its first recession in years.
One of the key rationales for the purchase of AK Steel was to gain access to the lucrative automotive market. Unfortunately, the car market is getting a severe blow as car sales are plunging all over the world. The iron ore prices have been holding well, but the drop in U.S. steel prices has intensified, which is not surprising in the current environment. The earnings estimates are going down and now point to a loss in 2020:
Source: Seeking Alpha Premium
The big problem is that these numbers are hardly "estimates" - they are "guesses", and you can't blame analysts for this. No one knows when the current lockdown measures will be lifted and how much time it would take for the economy to get back on track.
In my opinion, the general market has been rather optimistic about the speed of the recovery after the crisis. I believe that it will take months before life in affected countries gets back to normal. The ongoing crisis will put significant pressure on disposable incomes and consumer confidence via unemployment, while some restrictions would likely have to stay in place for weeks and months to prevent a second wave of the pandemic.
In this situation, it is impossible to evaluate the exact impact of the coronavirus crisis on Cleveland-Cliffs earnings in 2020. The company will surely report a loss, but the size of this loss is unknown. During a crisis, liquidity is much more important than the accounting profit or loss, and Cleveland-Cliffs was lucky to complete its refinancing just before the crisis so that it now has four years without maturities.
This is the strongest part of Cleveland-Cliffs value proposition in the current environment. We are in the early days of the crisis, but it is clear that banks will be picky about providing additional liquidity to leveraged firms. Fortunately, for Cliffs, it now has four years before the first debt maturity is due, which provides it with sufficient flexibility in these uncertain times.
Another unknown is the potential infrastructure bill, which was proposed by President Trump several days ago. The fate of the original infrastructure bill, which was one of the hot topics at the beginning of Trump's presidency, makes me feel uncertain about the timing and the practical realization of such a bill.
Currently, all effort goes to containing the epidemic and providing consumers and businesses with lifelines that will put them through the crisis. Once the epidemic is contained, the hottest part of the race for the U.S. presidency will begin. It remains to be seen whether there will be a time for the infrastructure bill in this schedule, especially given the fact that this bill will require even more debt on top of existing measures. While the potential infrastructure bill could provide some background support for steel stocks, I don't expect any real-life impact in the near term.
Longer term, Cleveland-Cliffs is positioned well to participate in the recovery. Short term, I'm not sure whether the negative impact from virus containment measures has been fully priced in the market. I must admit that I find it hard to believe that the bear market, which was caused by what could easily be the biggest recession of this century, ended in just a month. While the unprecedented measures announced by governments and central banks all over the world could help the markets, we haven't yet seen the full data on the true economic impact of the current healthcare crisis. Thus, while I'm inclined to participate in the upside momentum above $4.00 if such momentum presents itself, I'm not looking for sitting through thick and thin with a speculative position since I expect another leg down in the markets which will likely impact most stocks.
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