What To Expect From Cleveland-Cliffs’ Q2 2019 Earnings Report?

Cleveland-Cliffs (NYSE: CLF) is expected to report its Q2 2019 financial results on July 19, 2019, followed by a conference call with analysts. Cleveland Cliffs’ revenues saw a y-o-y decline in Q1 2019, driven by a 10.7% decrease in the average realized product revenue rate. The market expects CLF to report a revenue drop of 12%-13% in Q2 2019. Lower revenue is likely to be a result of the loss of revenue from the sale of the APAC (Asia-Pacific) business in mid-2018. On a sequential basis, revenue is expected to see a sharp rise in Q2 2019 over Q1 2019, primarily due to a pick up in global iron ore prices and base effect (as Q1 is the weakest quarter for the company during a year). Earnings are expected to come in at $0.56 per share in Q2 2019, marginally higher than $0.55/share in the year-ago period, mainly due to the sale of the loss-making APAC operations, partially offset by higher maintenance, transportation, and stripping cost.

We have summarized our key expectations from the announcements in our interactive dashboard – Cleveland-Cliffs’ Earnings: Performance and 2019 Forecast.  In addition, here is more Materials data.

A Quick Look At CLF’s Revenue Sources

CLF reported total revenue of $2.33 billion in FY 2018. The company has only one operating segment as follows:

Mining and Pelletizing: This segment contributes 100% of the company’s revenues. The Mining and Pelletizing segment is a major supplier of iron ore pellets to the North American steel industry from its mines and pellet plants located in Michigan and Minnesota.

A] Revenue Trend

• Revenue from iron ore sales remained strong in 2018 due to higher volume and premium pricing. However, iron ore sales were down by 14% (y-o-y) in Q1 2019, mainly due to a decrease in volume and lower price realization.
• CLF is expected to witness a y-o-y decline in pellet volume sold in Q2 2019 due to the loss of volume from APAC, partially offset by the addition of two new contracts in 2018.
• Though iron ore prices remained elevated for most of 2018 following China’s new environmental policy announcement, prices declined in Q1 2019 as steel mills in China started offloading inventories and shedding capacity due to low margins, and unfavorable customer mix by CLF driven by a higher proportion of rail shipments.
• However, iron ore price realization is expected to improve in Q2 2019 over the previous quarter and remain around previous-year levels, driven by the recent jump in iron ore prices due to reduced supply as Vale cut its production target following the accident at one of its dams.
• Thus, on a year-on-year basis, stable price levels and a decrease in volume is expected to lead to a drop in iron ore revenue for CLF in Q2 2019.

B] Expenses and Profitability Trend

Total expense in Q2 2019 is likely to see a marginal drop over the previous year period due to decrease in interest expense and stable SG&A expense levels, offset by higher maintenance, transportation, and stripping cost.

• Cost of Goods Sold (COGS): Cost of sales has been continuously increasing over the last four quarters and we expect this trend to continue in Q2 2019. Higher COGS is likely to be driven by higher maintenance cost, reduced energy rebates, along with increased transportation and stripping cost.
• SG&A Expense: Though SG&A expense decreased sequentially in Q1 2019, it was higher on a y-o-y basis due to increased employment costs, including severance, and incentive-based compensation. SG&A expense is expected to remain flat in Q2 2019.
• Interest Expense: Interest expense has steadily declined over recent quarters and we expect this trend to continue in Q2 2019, driven by benefits of debt restructuring activities of 2018 and capitalized interest related to the HBI production plant and upgrades at the Northshore plant.

Net income margin is expected to see a marginal uptick in Q2 2019 compared to Q2 2018, driven by lower interest outgo, flat SG&A expense, partially offset by rising cost of sales.

Full Year Outlook

• For the full year, we expect revenue to decrease marginally from $2.33 billion in 2018 to $2.32 billion in 2019, driven by loss of volume from the sale of APAC operations, partially offset by stronger premium pricing through 2019.
• However, the trend is likely to reverse with revenue expected to increase to $2.34 billion in 2020, driven by growth in production and volume sold, along with the premium pricing environment projected to continue.
• Additionally, the new hot-briquetted iron (HBI) plant is expected to add to the company’s volume from mid-2020.
• Though CLF is expected to receive $117 million in tax refunds in Q3 2019, it is still much lower than the benefit of close to $490 million received in 2018, which would, in turn, translate into net income margin of 22% in 2019, much lower than 48.4% in 2018.
• In spite of interest savings, margins are expected to further drop to about 18% in 2020 as the company would be spending much more on the operations and logistics of the new HBI plant during the year.

According to Cleveland-Cliffs’ valuation done by Trefis, we have a price estimate of $13 per share for CLF’s stock, which is higher than its current market price. We believe that premium pricing for the company’s high-grade ore, expansion of production capacity from 1.6 million metric tons to 1.9 million metric tons at the new HBI (hot-briquetted iron) plant in Great Lakes, and upgradation of its Northshore plant to replace up to 3.5 million long tons of blast furnace pellet production with DR-grade pellet production, is also expected to support growth in the stock price going forward.

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