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Jul 6, 2021
[7 min Read]
You've probably recently seen CLF on WSB, CNBC, and all over the place lately? Why is that…? Because Steel is going fucking crazy right now, and CLF is ahead of the curve.
So, what's the play? Why is it a play? How is it play? Buckle up boys: close out of porn hub, grab a beer, and prepare for your smooth brain to gain a half-wrinkle. You're going to be here a while.
Let's start with the company, Cleveland Cliffs. This company is 174 fucking years old, employs 25,000 people, and it's traditionally been the largest and oldest independent iron ore mining company in the USA. They own or co-own five active iron ore mines in Minnesota and Michigan and maintain an annual rated iron ore production capacity of approximately 28.0 million long tons.
Ok, so what? Who the fuck cares - mining and steel production isn't sexy, pink-haired septum pierced hippies hate it, and it's barely a blip on Wall Street's radar. Guess what- I care, and you should too.
When evaluating a company, there are several dimensions to look at - the people and their long-term strategies behind the company are some of the most important. Let's go deeper.
Cue in Lourenco Goncalves. This maniacal son of a bitch joined CLF seven years ago as CEO through a contested proxy battle and he's been transforming the company and telling Goldman Sachs analysts they are embarrassments to their parents ever since. The fucking balls on this guy. This is the kind of guy you want on your team. He's nuts, but he's going to prove everyone else wrong and get shit done. In the last seven years, LG's entire initiative and strategy has been to completely transform an overleveraged wilting company, into what it is today - the USA's largest flat-rolled steel company and the largest iron ore pellet producer. But again, big whoop, right? Who the fuck cares? Let's go deeper.
Transformation: Operational Strategy
So, what's changed? Just last year, CLF acquired two major steelmakers: AK Steel and ArcelorMittal USA. THIS IS HUGE and what Wall Street hasn't seemed to fully process. With this move, CLF has set itself up to own the entire aspect of the operations process and now they are VERTICALLY INTEGRATED. This means that they own and control everything upstream and downstream - from ore in the ground to selling products to end-user customers. This gives them added scale of operations, greater market share through acquired accounts, new markets, less competition, operational leverage, cost savings throughout the supply chain, and more. Imagine if Volkswagen bought Porsche and Audi to gain more market share and leverage efficiencies? Oh wait, they already did that because that's what successful & growing companies do to become even more successful. They see a bigger picture and take a short term loss for the much more profitable long term gain.
Customers and Revenues:
CLF's main bread and butter is selling steel to the automotive industry. You know, the industry that has been getting fucking insane valuations with EV's; the industry that S&P Global expects to grow another 15% this year despite the chip shortages? Yeah, that industry. What's great is that AK Steel, now owned by CLF, had 63% market participation in the auto industry, “…which no other steel mill in the entire world can replicate”, according to Goncalves on CNBC. Taken from CLF's 10-K: “Due to the much larger operational footprint we now have, we anticipate synergies of approximately $310 million from asset optimization, economies of scale and streamlining overhead, over half of which has already been set in motion. “
Right now, CLF maintains their revenues per vertical as follows (From 10-k):
Automotive 45 %
Infrastructure and manufacturing 15 %
Distributors and converters 13 %
Steel producers 27 %
Again, so fucking what? Why so many numbers? Who gives a shit, what does it mean? Guess what: I give a shit, and you should too. Here's what it means:
"The exacting requirements for servicing the automotive market generally allows for higher selling prices for products sold to that market than for the commodity types of carbon and stainless steels sold to other markets. As the only North American producer of high-efficiency NOES (Non-Oriented Electrical Steel), which is a critical component of H/EV motors, CLF is positioned to potentially benefit from the growth of H/EVs going forward. Likewise, the growing customer adoption of H/EVs may also increase demand for improvements in the electric grid to support higher demand for more extensive battery charging."
For those who can't read good - the auto industry in particular needs precision requirements from steel inputs for safety and efficiency. This means CLF can charge higher prices for a more technical product and the players in the space are limited. Who do you think can spin up an iron ore mine, build a factory to roll steel, and sell it to the end customer? Nobody but the players already in the space. It would take Amazon at least 5 years to be ready to capitalize on this market (Mining permits, Ecological Studies, Building permits, Construction, Operational spin up, etc.) The players in the space are all that are it - and CLF just ate two of them.
Ace the hole:
Added onto this, the prices of steel have tripled, and there is no end in sight. Every month, pricing keeps going higher. This translates to pure tendies. This won't last forever, but damn… two good years of boosted profits is a hell of a tail wind coming right off of two huge ground shaking acquisitions. It's a great set-up and CLF is taking full advantage of it by paying down long-term debt, de-leveraging risk, and returning money to the shareholders (Goncalves words, not mine). Notice how I haven't even mentioned the trillion-dollar infrastructure bill yet - which happens to fall under at least 42% of CLF's revenue stream. I don't know enough about the bill to properly factor in what and how much of a benefit CLF may see from it, but it's not hard to imagine how a steel company would benefit from a $1T infrastructure spending spree.
By now, I'm sure you're holding that small, yet rock hard banana in your pants and you're already thinking of how you're going to tell your wife's boyfriend Axel that you don't need his weekly allowance anymore. Not so fast, we have more work to do.
So, let's assume that CLF is undervalued. Let's assume that Wall Street is too focused on tech at the moment and overlooked this small, yet well-established and fast-growing steel maker in Ohio. Let's assume that steel prices will maintain their highs for another year. If CLF is undervalued, then what is it actually worth?
JP Morgan thinks $39
UBS thinks $28
BofA thinks $25
Goldman Sachs thinks $20 (fuck Goldman)
Right now, I'm at $32.25
I've combed through their financials, 10K's and most recent 10-Q after their Acquisitions to get the best numbers I can and come up and a price which I think is conservative. Disclaimer: I'm not a professional - I believe my numbers are good, but not perfect. I could have missed something or multiple things, it's almost certain that I did. This isn't financial advice. My assumptions could be off and my estimates are approximations. If you see something that I missed, overlooked, or think that I'm retarded, please tell me and I'll revise it.
My Main Assumptions:
- Steel prices will continue roaring through end of this year, and maybe until Q3 of 2022.
- CLF will use their profits to pay down long-term debt and finalize their newly acquired assets, which is what they have said they will do
- Their new business operation will yield new efficiencies and synergies where they can lower their Cost of Goods Sold (historically around 75%). In my projections, I've tweaked COGS to be a bit higher in the next couple of years to account for the overall chaos of two crazy big acquisitions, and due to the fact that the reason why the number has been so large in Q4 2020 and Q1 2021, was they were moving all of their new assets and steel inventories around the US, which translates to a lot of shipping cost because steel is heavy.
- I'm assuming that next year they will start to lower their inventories, which I believe are currently bloated from the acquisitions.
- I did not factor in any other new broad sweeping strategy plays or acquisitions
- Many of my projections are based on trend functions, averages, or general educated guesses.
- “Hey wait a second, you show that CLF will only show $1.4 billion income for 2021, but they upgraded guidance to expect $5 billion this year”. Correct, but that number shown in the pretty graph in the 10-k is “Adjusted” EBITDA, which is a non-GAAP measure. Nothing wrong with that, but I prefer to evaluate via GAAP and Un-Adjusted.
Ok, I'm jacked to the tits and ready to "Invest". What's the play?
Looking at it from a TA perspective at daily candles, the steel sector has been ripping the last 6 months, creating an ascending triangle. What I see happening in the next month or two is another leg up - right into that $30 zone and maybe hit $35 by EoY depending on steel prices. CLF earnings are on 7/22, which I think there will be a run-up to, and/or the day of. Hard to say. In addition to that, Steel is a long play in and of itself.
If you are risk-tolerant and want something short-term, play the earnings call. If you are more conservative - go for deep ITM LEAPS, which is what I'll be doing.