After An Impressive Performance In 2018, Can CLF Manage To Cash-In On Vale’s Operational Issues?

by Trefis Team
Cleveland-Cliffs Inc.
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Cleveland-Cliffs Inc. (NYSE: CLF) announced its Q4 2018 results on February 8, 2019 followed by a conference call with analysts. The company’s earnings were way above market expectations. CLF reported revenue of $696.3 million in Q4 2018, 36% higher than $511.8 million in Q4 2017, driven by a 21% increase in pellet sales volume and a 19% rise in realized price per ton. The company’s diluted EPS increased by more than 92% from $1.03 in Q4 2017 to $1.98 in Q4 2018. For the full year, total revenue increased by 25% to $2.3 billion and EPS nearly trebled to $3.71 in 2018 from $1.26 a year ago. Along with higher volume and prices, the superior earnings were largely driven by a $461 million release of a tax valuation allowance in the U.S.

The major takeaways from the announcement have been illustrated in the graphs using our interactive dashboard – CLF Beats Market Expectations In 2018.


Key Factors Affecting Earnings

Increase in volume and prices: Iron ore volume increased by 10.1% to 20.6 million tons in 2018 from 18.7 million tons in 2017. The increase was a result of healthier customer demand, two additional customer contracts that did not exist in 2017, and mills stocking up ahead of winter, which was slightly offset by unanticipated gale force winds in the Great Lakes, which limited shipping capabilities during October and November. The year also witnessed an increase of 20% in revenue per ton to $105.64 from $88.03 in 2017. This was primarily driven by increased steel pricing and pellet premiums, which were magnified by favorable contract structures. Environmental curtailments in China pushed prices of premium ores higher in 2018, which benefited CLF. Additionally, even though there was a decline in international iron ore prices in mid-2018, CLF’s operations are more closely linked to demand-supply dynamics within the US, which remained favorable for the company. Higher prices and volume led to a 25% increase in revenues to $2.33 billion in 2018 from $1.87 billion in 2017.

Higher Margin: As CLF has sold almost all the assets from its loss-making APAC operations, the overall margins of the company have seen a rise in 2018.  Additionally, the interest expense declined during the year as CLF redeemed all its outstanding Senior Notes due 2020 (with a principal balance of $211 million) in October 2018. However, the single biggest factor that boosted margin was a $461 million release of a tax valuation allowance in the U.S. Net income margin increased from 19.7% in 2017 to 48.4% in 2018. The margin growth momentum was partially affected by an 11% increase in cash costs per ton to $65.43 in Q4 2018 from $58.7 in the year-ago period, mainly driven by an unfavorable LIFO impact of $15 million, as well as higher employee-related expenses and royalties.

Future Growth Prospects and Risks Involved

CLF plans to increase the productive capacity of the Toledo HBI (hot-briquetted iron) plant from 1.6 million tons to 1.9 million tons, which is an indication of good demand for the product and a catalyst for future growth and value creation. With an increase in operating cash flow to $478.5 million, healthy cash balance of $823 million, and $117 million of cash tax refunds expected in Q3 2019, CLF is expected to easily be able to dedicate $425 million to this expansion. Additionally, competitor Vale S.A. has cut its production estimate for 2019 after the recent accident at its Brazilian site, post which there has been a lot of movement in CLF’s stock price. This provides companies like CLF an opportunity to take advantage of a likely increase in higher iron ore prices. CLF expects to realize $111 to $116 of revenue per long ton in 2019, compared to $113 in 2018. It would be interesting to see if CLF is able to eat into Vale’s share in 2019 or it misses the opportunity.

ArcelorMittal, in its recent earnings announcement, projected a 0.5%-1.5% decline in demand for steel from China in 2019. This would affect steel prices and in turn rub off on the iron ore players. Though CLF has 100% of its exposure in the U.S., it is not immune to the trends in the global iron ore and steel markets. Taking these risks and opportunities into account, we believe that total revenues would likely be marginally higher at $2.35 billion in 2019, which marks an increase of 1% over $2.33 billion in 2018. Net income margin is expected to be at 48% in 2019, driven by lower interest expense and cost savings from the closure of APAC operations, offset by the absence of any large tax allowance like the one received in 2018.

We have a price estimate of $11 per share for Cleveland-Cliffs.


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