STLD - Cleveland-Cliffs Q3 Earnings: What Can We Expect?

2023-10-18 16:30:17 ET

Summary

• Cleveland-Cliffs Inc. saw its share price slump by 8%, likely due to general risk-off sentiment in markets and macro concerns.
• Other steel companies also experienced share price slumps, suggesting the downward move in CLF stock was macro-driven.
• Cleveland-Cliffs will report its fiscal third-quarter earnings next week, with analysts expecting a small decline in revenues compared to the previous year.

Article Thesis

Cleveland-Cliffs Inc. ( CLF ) will report its quarterly earnings results on October 23. We will take a look at what investors can expect while also delving into the longer-term outlook. With its valuation having dropped significantly from the highs seen earlier this year, Cleveland-Cliffs could be a good value pick at current prices.

What Happened?

On Wednesday, Cleveland-Cliffs Inc. saw its share price slump by 8%, which made the stock hit a price in the low $14s. This is at the low end of the six-month trading range:

There was no major company-specific news item that would explain this steep share price drop, which is why the downward move was likely driven by general risk-off sentiment in markets due to macro concerns. The broad market dropped on Wednesday as well, and rising treasury yields also were a headwind for stocks. Last but not least, it's worth noting that other steel companies saw their share prices slump as well:

United States Steel Corp ( X ), which is a takeover target, performed the best among the group, but Nucor Corp ( NUE ), Steel Dynamics, Inc. ( STLD ), and ArcelorMittal S.A. ( MT ) were all down 5%-8% as well, suggesting the downward move we have seen at CLF was macro-driven, as the entire industry was affected.

The share price slump is still important for current and future shareholders, however -- including due to the fact that CLF is now considerably cheaper than it was last week.

Cleveland-Cliffs Q3 Earnings Outlook

Cleveland-Cliffs Inc. will report its next quarterly earnings results, for its fiscal third quarter, on October 23, post regular market hours. Let's take a look at what investors can expect.

The analyst consensus estimate for Cleveland-Cliffs revenues for its fiscal third quarter currently stands at $5.53 billion, which would represent a small decline of 2% compared to the previous year's period. Over the last three months, analysts have made two downward revisions and one upward revision to their revenue estimates, according to Seeking Alpha's data . Revenues being almost flat compared to the previous year's period would be a very solid result, I believe, although it wouldn't be great. But considering the macro headwinds such as rising interest rates and strikes at large automobile companies such as Ford ( F ) and General Motors ( GM ), revenues being down marginally would be far from disastrous.

Over the last ten quarters, Cleveland-Cliffs has beaten revenue estimates six times, while missing the consensus revenue estimate four times -- the track record is thus mixed, but slightly positive. Compared to the second quarter, $5.53 billion in revenue would be a weaker result, but revenues would be up compared to the first quarter. Overall, $5.53 billion would be more or less in line with the H1 pace, which, I believe, would be far from bad considering the multiple macro headwinds the company is facing.

Looking at the profits that the analyst community is forecasting for Cleveland-Cliff's third quarter, we see a consensus earnings per share estimate of $0.44. This would be up considerably versus the previous year's quarter, despite slightly lower revenues being forecasted. Lower energy costs play a role in the big expected earnings increase -- the consensus estimate implies an earnings per share growth rate of 55%. All kinds of energy commodities were very expensive last year, including oil, gas, coal, and even electricity. Overall, prices have pulled back for many of these, which is a positive for the profitability of energy-intense businesses such as Cleveland-Cliffs.

Many investors will also be highly interested in the cash flows that Cleveland-Cliffs has generated during the third quarter. After all, cash flows are relevant for many things the company is doing or plans to do: Cash is needed for debt reduction, for investments, for shareholder returns, and cash would also be needed for M&A -- with United States Steel being a potential takeover target, Cleveland-Cliffs has good reasons to stack up cash.

For the first six months of the current year, Cleveland-Cliffs has generated operating cash flows of around $850 million, according to the most recent 10-Q filing that is available here . If the company's cash generation is on a similar level during the second half of the year, we could be looking at quarterly cash flows of a little more than $400 million, while full-year cash flows could come in around $1.7 billion. Adjusted for capital expenditures (around $320 million during the first half of the year), annual free cash flows could be in the $1 billion to $1.1 billion range for the current year. Considering Cleveland-Cliffs is valued at $7.5 billion right now, that makes for a pretty low free cash flow multiple of around 7. In other words, Cleveland-Cliffs is valued at a free cash flow yield of around 14%, assuming H2 free cash generation is comparable to what we have seen during the first half of the year (which isn't guaranteed, of course). This gets us to the next important point: Cleveland-Cliffs is pretty cheap right here.

CLF Stock: A Value Pick

Not only is Cleveland-Cliffs trading at a pretty low free cash flow multiple, but the company also looks inexpensive when we look at other valuation metrics. Based on this year's forecasted earnings per share of $1.51, the company is currently valued at around 9.5x forward net profits.

Looking beyond 2023, the valuation gets even better: Analysts are currently predicting earnings per share of $1.95 for the next year, which implies an earnings multiple of a little more than 7. Finally, analysts are forecasting that Cleveland-Cliffs will earn around $2.50 during fiscal 2025, which would result in a 2025 earnings multiple of less than 6, which would be very cheap. Of course, we don't know what the macro environment will look like two years from now, so these estimates should be taken with a grain of salt.

Cleveland-Cliffs has considerable debt levels, which is why we should also take a look at the company's enterprise value to EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio. The EV/EBITDA ratio accounts for debt and cash on the balance sheet and is thus a useful metric for evaluating indebted companies:

Based on current estimates for this year, Cleveland-Cliffs is valued at 5.8x this year's expected EBITDA right now. Oftentimes, single-digit EV/EBITDA multiples are seen as inexpensive -- Cleveland-Cliffs thus looks pretty cheap. Compared to how the company was valued in the past, CLF is inexpensive as well -- the 5-year median EV/EBITDA multiple implies a discount of around 10% at current prices. Since the company's enterprise value also accounts for CLF's debt, its equity would need to climb by around 16% for the company to trade in line with the longer-term median valuation.

As Cleveland-Cliffs has been reducing its debt levels in the recent past, and since the company will likely continue to do so, its enterprise value will decline over time, all else equal. Even at a constant enterprise value, CLF's share price and equity valuation could thus increase over time, as debt reduction shifts value from debt holders to equity holders.

CLF's Longer-Term Outlook

Steel is a cyclical industry, and that will always remain the case. But Cleveland-Cliffs is well-positioned to perform well over time, thanks to its strong position when it comes to supplying automobile companies and due to (energy) cost advantages compared to competitors from markets such as Europe.

Supply-chain onshoring, the "build in America" movement, and legislation and subsidies that help with these trends are beneficial for steel producers in the United States, and CLF should be among the companies benefitting from this.

While some investors don't like the high debt levels, Cleveland-Cliffs' management has guided the company well over the last couple of years, I believe. As debt levels decline over time, the company will have more room for shareholder returns -- especially buybacks that seem attractive at the current pretty low valuation.

With Cleveland-Cliffs now trading at the low end of the 2023 trading range and changing hands for a single-digit 2023 earnings multiple, it could be a good time to enter or expand a position in this steel producer for those who are interested in exposure to the industry and that like management's vision for the company.

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