2023-10-25 12:24:52 ET
Summary
- Mesabi Trust's near-term value depends on the actions of Cleveland-Cliffs Inc., which operates the Northshore iron ore mine.
- Cleveland-Cliffs idled the Northshore mine in 2022 and restarted it in Q2 2023, but CEO Goncalves has threatened to use it as a swing operation.
- Northshore is not likely to be shut down soon, as Cleveland-Cliffs is faced with robust demand and may want to safeguard its reputation while pursuing acquisitions in steel making.
I've recently written several articles on the Mesabi Trust (MSB) because I think it is an interesting special situation. The last article is fairly recent, but Cleveland-Cliffs Inc. (CLF) just held its Q3 earnings call , and Mesabi Trust's near-term value highly depends on that company's actions.
Cleveland-Cliffs operates the Northshore iron ore mine. Mesabi Trust derives all its income from this operation. Cleveland-Cliffs idled the Northshore Trust in 2022 and only restarted it in Q2 2023. Cliffs CEO Goncalves has also threatened to use the mine as a swing operation. Here's a quote from an MPR article on the royalty dispute (emphasis by me):
Cleveland-Cliffs will idle its Northshore Mining operations in Babbitt, Minn., and Silver Bay, Minn., amid a royalties dispute and as the use of scrap metal in its electric arc furnaces reduces the need for its pellets .
The Silver Bay pellet plant and the Babbitt mine will idle May 1 and last into at least the fall as the company moves production of direct-reduced grade pellets to its Minorca Mine in Virginia, Minn., Cliffs CEO Lourenco Goncalves said in a year-end earnings call with investors Friday morning.
"Because we are now able to produce (direct-reduced) grade pellets at Minorca, and mainly due to the ridiculous royalty structure we have in place with the Mesabi Trust, we will be idling all production at our Northshore Mine. ... No production, no shipments, no royalty payments," Goncalves said in the call.
Further down the article, it says:
The DR-grade pellets supply Cliffs' new Toledo hot briquetted iron plant, which in turn feeds electric arc furnaces.
Because the company uses more scrap metal in its electric arc furnaces, the idling could be prolonged, Goncalves said.
In my previous article, I went over the Mesabi quarterly numbers and how it looks like the mine is in near full production. The Cliffs call gives a lot of hints of what production will look like going forward. Here's the first Goncalves quote I found interesting. To put it into context, Goncalves is gushing on the call about the automotive demand and the outlook there:
As I have said before, our steel buyer for a giving car manufacturer can replace Cliffs with another steel supplier just to buy cheaper steel from them for a little while, but history tells that they will come back to Cliffs after the buyer or the decision maker above him or her, or both the buyer and the boss are replaced with someone else. We have seen that happen time and time again.
Several analysts on the call asked what Cliff's will do to save costs. Goncalves is repeatedly given the opportunity to say something about the iron ore feedstock, but he never mentions feedstock or Northshore. Here's an example (emphasis added):
Analyst: Celso or Lorenzo, can you talk about other initiatives that you may have more on productivity or more efficient labor deployment, or any other changes on how you do -- how you make steel besides the savings on raw materials that you can point to? And if you have any quantification of those that would be really interesting to get any color.
Lourenco Goncalves
Yeah. Look, well, our work done back in the second half of 2022 when we deliberately reduced throughput in order to fix the equipment that we bought from ArcelorMittal USA , that was in much worse shape than the equipment that we bought from AK Steel. We did that knowing that our results would take a hit, the results took a hit. And since then, we are demonstrating that good equipment and good people, good union labor force can produce a lot of steel. So three quarters in a row, in an environment that's not the most vibrant I have ever seen, for sure, we have seen better than that. We are delivering more than 4 million, shipping more than 4 million net tons of steel three quarters in a row. So, so far, so good.
Here he's saying they deliberately shut down production to fix equipment and says it meant results were the worse for it. He continues (emphasis added):
Productivity has been achieved and it's not productivity, just producing commodity hot roll. We produce all kinds of very sophisticated products for a very demanding customer base that is primarily automotive and other OEMs. So we are very satisfied with our level of productivity. So other cost initiatives are all related to the fact that we are a big buyer of everything like we did with coal, big buyers tend to have a good treatment from the suppliers, particularly if the big buyer knows how to buy. We nailed with coal. Let's face it.
We close our deal at the perfect timing, because remember this was a mining company before we understand commodities, so we know how to negotiate these things. So I'm not going to elaborate beyond that, Carlos, but that's basically what we do. Celso wants to complement something.
The Northshore operation produces a very high-quality feedstock in pellets and it doesn't sound like he wants to go without it anytime soon.
A secondary reason I'm doubtful Goncalves is going after the trust soon is that it means laying off a lot of workers and bad press. Meanwhile, Cliffs is involved in a process to be a potential buyer of United States Steel Corporation (X). The company signed an NDA to get access to the books there. It briefly commented on the call how that's still in force (until December 1st):
I want to provide another brief disclaimer. Back in August, we announced a potential exciting and transformational opportunity for Cleveland-Cliffs. Since then, restrictions have been put in place on what we can say or disclose, and therefore, for the time being, we cannot discuss the issue. So before you start wondering why you'll not hear anything about it, that's why.
To add to that Goncalves was very appreciative of the Biden administration on the call, regulators unions. In my humble opinion, this is a bit uncharacteristic and it is likely meant to get ahead of regulatory/union objections to a combination of U.S. Steel and Cliffs.
On that note, I want to emphasize one more important point. We appreciate the value that the Biden administration places on projects and investments that sustain and grow good-paying middle-class union jobs. Regulatory authorities have been strict on fighting M&A deals that harm workers, and rightfully so. Most of you have followed Cleveland-Cliffs for years and are very familiar with the way in which Cleveland-Cliffs works collaboratively with our union partners, in particular, the USW, the UAW, and the International Association of Machinists. I'm grateful that President Biden's administration is aligned with us in our long-term collaborative approach with the unions and has taken notes that Cliffs puts workers at the center of our strategic decisions and growth objectives.
If Cliffs is trying to grow by getting more and more steel assets (and so far they've been very savvy about picking off big operators), it becomes increasingly important that they're not viewed as a predatory ruthless profit-maximizing company that sends hundreds of workers home to put pressure on other partners. If it takes over U.S. Steel, that's probably going to take at least 6-12 months. I don't see them shutting down Northshore again while that's ongoing.
In my last article, I talked about a normalized annualized forward yield of 8.2% to 11.4% (full production over a full year). That still seems quite feasible to me. I also said this compares well with bonds. I rightfully got some pushback on that. The 10-year (US10Y) yields around 4.8%, while bills can get you as much as 5.5%. The problem with bills is that the yield can quickly disappear and you can't buy it again. The so-called reinvestment risk.
The 10-year yield of 4.8% is quite attractive. In fact, I just argued in favor of it myself. It is not as high as the long-term normalized yield I expect here, but it is much less volatile. The longer bonds are vulnerable to inflation. The fixed-rate gets destroyed in inflationary periods. A trust like this tends to benefit from inflation because commodity prices rise as well.
Finally, a regular treasury will never pay more than a certain fixed amount. A trust like this benefits from the occasional unexpected price spike. Dividends can get very high for brief periods. On the flipside, as has been shown with Northshore, the dividends can also go to zero for a short amount of time.
In the end, I came out liking Mesabi Trust as an addition to my portfolio (partially offset by shorts in major iron producers). However, if you think Goncalves will keep idling Northshore and sending everyone home, then the 10-year at 4.8% may well be the better bet.
For further details see:
Mesabi Trust: Unlikely Cleveland-Cliffs Shuts Northshore Down In The Near Term