Although Cleveland-Cliffs (CLF) is down more than 25% from its all-time high, the stock represents a great investment opportunity as its growth potential is likely to result in a significant price gain.
It is important not to panic about the temporary bear market and instead remain calm and reasonable. I am bullish on the stock.
About Cleveland-Cliffs
Cleveland-Cliffs is the largest producer of flat-rolled steel and iron ore pellets in North America. The company also produces the raw materials it needs. It is engaged in mining, applying specific ferrous metallurgy techniques, in addition to recycling scrap and metallurgical waste.
The company serves multiple industries in North America, including automotive and manufacturing, while providing a reference point for infrastructure builders.
The company is headquartered in Cleveland, Ohio, and employs approximately 26,000 people in its North American operations.
Current Headwinds
Should the Cleveland-Cliffs share price drop another 25%, which is possible given current global macroeconomic conditions, it would be reasonable to increase the number of shares.
Given the excellent prospects for demand and steel prices, the expected upside for Cleveland Cliffs stock should be strong, and likely to occur after the current negative momentum.
What Drives the Stock Price Down?
Currently, two factors are weighing on Cleveland Cliffs stock.
One is less impactful but will continue for many weeks to come, the other does a lot more to explain the current fall in steel stocks, but it will end much sooner than those feeding the bearish sentiment expect.
The first reason is the war in Ukraine. Strong concerns about the regular shipment of Russian fossil fuels to Europe are driving up the price of these two commodities dramatically.
The stock market seems to have a unique interest in the additional profits of these oil and gas producers, while fiscal threats from the G7 countries are not enough to discourage high traders’ speculative tendencies.
The downward pressure on the share price will continue as long as there is tension in Eastern Europe, but of the two factors mentioned, this should worry Cleveland Cliffs shares the least.
Fossil fuel prices were already rising before the war began, raising concerns about the potential impact of production costs on profits, but the stock still performed well. Thus, the headwinds from fears for oil and gas supply explain the current price decline to a lesser extent than the following factor.
Steelmakers are pulling back after imposing lockdowns and other containment measures in China’s megacities, and other smaller urban areas to contain the spread of another wave of COVID-19 infections.
With China’s zero-tolerance program against COVID-19 affecting the activities of ports and major trading hubs in the world’s second-largest economy, there are currently concerns over the regular supply of iron commodities.
With China being the world’s third-largest iron producer (340 million tons mined in 2020), analysts are in principle right about the deteriorating growth outlook for the steel sector.
Expectations now point to potential supply chain issues, an increase in the volume of outstanding orders, and essentially a slowdown in metallurgy manufacturing activity.
Chinese Signs of Recovery
The headwinds from China should improve soon for the following reasons.
It seems that the government has already started lifting restrictions in urban areas. Significantly, in Shanghai, 70% of the top 1,800 companies have resumed operations and production amid the city’s new wave of COVID-19.
In addition, China’s industrial and supply chains are showing resilience despite the short-lived impact of the government’s epidemic containment measures, said He Hui, assistant to the president of the China Federation of Logistics and Purchasing (CFLP) last week.
Plus, with nearly 90% of China’s total population completing the vaccination cycle (according to the latest data from the National Health Commission), the resumption of economic activity and the return to normal should progress very rapidly.
Not to mention that the government continues to provide financial support to both families and businesses operating in the sectors hardest hit by the new wave of infection. This policy should protect against the risk of a worrying economic slowdown.
Upside Catalysts
The situation in China sets the stage for a sharp rise in the price of ready-to-process iron ore as the Chinese government decouples urban life and economic activity from coronavirus containment measures.
While most of its competitors face higher production costs, Cleveland Cliffs won’t because the company can mine iron ore from its own deposits in Minnesota and Michigan, with notable savings in rolled steel and iron microsphere production.
Additionally, pent-up demand for steel products could drive anomalous sales in the second half of 2022, which would be incredibly beneficial for Cleveland Cliffs.
Cleveland Cliffs would also benefit from a likely increase in U.S. spending on public infrastructure, implying a rising demand for iron and steel products.
Runaway inflation, rapid and repeated rises in interest rates, and the steady appreciation of the U.S. dollar against local currencies and especially against the Japanese yen are weighing on private spending, investment, and the U.S. trade balance.
The road to higher public spending on infrastructure to revive domestic economic growth is practically paved.
Looking ahead to full-year 2022, Cliffs has higher average selling price expectations of $1,445 per net tonne versus the previous guidance of $1,225 per net tonne. This is due to better-than-expected conditions on certain fixed-price contracts and higher prices of products.
Strong Balance Sheet
The company’s growth plans are backed by a good balance sheet.
Although total debt of $5.03 billion versus just $35 million in cash suggests the financial position is heavily leveraged, shareholders should not be concerned.
Nor are higher borrowing costs due to a tightening of monetary policy by the U.S. Federal Reserve to combat elevated inflation, as the interest coverage ratio of 14.21 suggests Cleveland-Cliffs can easily bear the financial burden of paying interest costs on time.
Ideally, this ratio should be at least 1.5.
Profitability and Production Targets
The company holds highly profitable operations, much higher than most peers as indicated by a 12-month EBITDA Margin of 28% versus 21.2%.
This is a very powerful ratio for measuring the profitability of Cleveland Cliffs and other capital-intensive business operators.
Should the catalysts outlined above work on this profitability basis, they can only result in a higher profit margin with unusually strong upside potential.
Wall Street’s Take
In the past three months, seven Wall Street analysts have issued a 12-month price target for CLF. The company has a Moderate Buy consensus rating based on five Buys, two Holds, and zero Sell ratings.
The average Cleveland-Cliffs price target is $35.14, implying 61.6% upside potential.
Valuation
Cleveland-Cliffs has a market cap of $11.8 billion, P/E ratio of 3.5, and a 52-week range of $15.81 to $34.04.
The stock has a price-book ratio of 2.5, a price/sales ratio of 0.6, price/cash flow ratio of 3.6, and a price/free-cash-flow ratio of 5.8.
Conclusion
Bearish sentiment has weighed on this stock’s performance, and may continue to do so in the coming days.
However, there are enough headwinds on the way that should lift the stock over the long term.
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