After rising more than 5x from its March lows of 2020, at the current price near $16 per share, Cleveland-Cliffs stock (NYSE: CLF) looks fairly valued at the moment. The stock rallied from $3 to $16 off its recent bottom compared to the S&P 500 which increased 67% from its recent lows. The stock has outperformed the broader market with the US government announcing a string of measures along with stimulus packages announced in other economies to keep businesses afloat, which led to a rise in iron ore and pellet prices. However, most of the rally in the stock price has come in the last 6 months during which time the stock jumped almost 3x. The primary driver behind such a healthy rise has been the decision to acquire the US operations of ArcelorMittal (deal was concluded in December 2020). This is the second major acquisition by CLF in 2020 after the deal with AK Steel. These acquisitions are expected to lead to almost a 9x jump in CLF’s revenues in 2021 (compared to 2019). Expectations of higher revenue and improvement in margins following the recent rally in global steel and iron ore prices will keep CLF’s stock around its current level. Our dashboard What Factors Drove 118% Change In Cleveland-Cliffs Stock Between 2017 And Now? provides the key numbers behind our thinking.
Some of the stock price rise between 2017 and 2019 is justified by the 6.6% increase seen in Cleveland-Cliffs’ revenues due to increased production and higher iron ore prices. This was offset by a 25% decline in profitability as net income margins dropped from 19.7% in 2017 to 14.7% in 2019. On a per share basis, earnings dropped 17% from $1.27 in 2017 to $1.06 in 2019.
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Though earnings dropped, CLF’s P/E multiple increased from 6x in 2017 to 8x in 2019 mainly due to higher revenues, the company’s expansion plans, and rising iron ore prices. The multiple dropped in early 2020 to 4x following the outbreak of coronavirus. It has since then increased sharply and currently stands at 15x, as iron ore and steel prices have rebounded post the stimulus announcements. We believe that the company’s P/E multiple will decline to a more realistic level of about 9x in the near term.
Where is the stock headed?
The global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. Lower demand from construction players and shedding of capacity by major steel companies, mainly in China, led to a drop in global iron ore prices in early 2020. Additionally, the lockdown affected the supply chain for companies like CLF, leading to a decline in production and shipments. This was evident in the recently announced results where pellet production dropped (y-o-y) 61% in Q2 2020 and 12% in Q3 2020, while shipments dropped 24% and 15%, respectively. Though total revenue increased due to the acquisition of AK Steel, the company’s traditional pellet business was hit significantly due to the pandemic. The company also reported a loss of $0.31/share and $0.02/share in Q2 2020 and Q3 2020, respectively, as against profits reported in the year ago period.
The lifting of lockdowns and easing of global supply bottlenecks is likely to help CLF, which is projected to lead to higher shipments post the crisis. Iron ore prices have rebounded sharply from $80/ton in April 2020 to over $165/ton in January 2021. Additionally, steel prices have also rallied over recent months, which is expected to benefit CLF after its foray into the steel space. Further movement in commodity prices and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Also, the US raw steel capacity utilization for the week ending 2nd January 2021 was 75%, which is lower than the 80% recorded in the prior year period. However, this is an improvement over the 51% utilization in the beginning of May 2020, which indicates that there are signs of a rebound in activity in the steel sector.
Thus, rising prices and capacity utilization at a time when CLF has entered the steel market bodes well for the company. CLF’s revenues are expected to rise from $2 billion in 2019 to over $18 billion in 2021, while operations will again turn profitable after losses in 2020. Such a sharp improvement in fundamentals have already been incorporated in the recent rally in CLF’s stock, which justifies its current market price. We believe that CLF’s stock will hover around its current level in the near term, with any major movement being dependent on the mitigation/exacerbation of the Covid-19 crisis and movement in the commodity prices.
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