Stock Market

According to Quiver Quantitative, Cleveland-Cliffs (NYSE:CLF) is the ninth-most commented equity on the Reddit r/WallStreetBets board for the past seven days. However, before you head down the Cleveland-Cliffs path and buy CLF stock, you might want to consider why it might not be a slam-dunk.

Source: IgorGolovniov /

Cleveland-Cliffs’ business might be rolling right now, but that doesn’t mean you should get on the bandwagon.

Here’s why.

CLF Stock and Zero Debt

InvestorPlace contributor David Moadel’s July 26 article about the company says it all: “Zero-Debt Goal Puts Cleveland-Cliffs on a Positive Path.”

It’s been so long since I’ve written about the iron ore producer; it is now the largest flat-rolled steel producer in North America in addition to its historical business producing iron ore pellets for steel producers. So, I guess if you can’t beat ’em [steel companies], you buy ’em. 

In March 2020 and December 2020, it completed the acquisitions of AK steel and ArcelorMittal USA, respectively. It paid $1.54 billion for AK Steel and $2.60 billion for ArcelorMittal USA. For the AK Steel acquisition, it issued 317 million CLF shares and assumed its debt of $914 million. In the case of ArcelorMittal USA, It paid $631 million in cash, issued 78.2 million shares of its common stock, and issued 583,273 of its Series B participating redeemable preferred stock. 

At the end of 2019, it had $1.76 billion in net debt. One year later, the company’s net debt was $5.28 billion or 3x higher. While Cleveland-Cliffs reported record Q2 2021 results on July 22, it still finished the quarter with net debt of $5.30 billion.

And that doesn’t take into consideration the company’s $3.84 billion in pension and other postretirement benefits (OPEB). 

According to my colleague, the company will undertake what its CEO describes as a “monumental” reduction of its debt in the second half of 2021, ultimately leading to zero net debt by the end of 2022. 

Turn On the Free Cash Flow

To achieve this, it plans to turn on the free cash flow (FCF) generation valve over the next six quarters. 

In the first six months of 2021, its free cash flow was -$166 million, considerably lower than the $581 million it used in the first six months of 2020. Nevertheless, that’s a 71% improvement over last year. In the third quarter, it expects FCF of $1.4 billion, which puts it in the positive column heading into Q4 2021. 

As its CFO, Keith Koci, said in its Q2 2021 conference call; it expects to have $5.5 billion in adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) for all of 2021. It expects its past net operating losses to cover most of its federal tax owing for the year. That should help with free cash flow generation.

In Q3 2021, it expects free cash flow to be approximately 78% of its adjusted EBITDA of $1.8 billion. Assuming the same is true for the entire year, it ought to generate full-year free cash flow of $4.3 billion and $3.07 billion in Q4 2021 [$4.3 billion less $1.4 billion in Q3 2021 and -$166 million for Q1 2021 and Q2 2021].

If it does generate $4.5 billion in free cash flow in the second half of the year, it could very well make a big dent in its net debt in 2021, making its zero net debt goal for the end of 2022 very doable.


The Fly in the Ointment

Credit Suisse analyst Curt Woodworth has a $28 target price on CLF stock and an outperform rating. He believes that Cleveland-Cliffs will stay on a roll through the remainder of 2021. 

“Looking ahead, we remain bullish on Cleveland-Cliffs as the company continues to optimize its large domestic steelmaking footprint and HBI asset and has brought a new commercial discipline to the integrated model,” reported Woodworth saying in a note to clients. “It’s important to note that Cleveland-Cliffs has significant upside potential across its contract portfolio, entering 2022 with ~30% of annual contracts set to reprice in 4Q-21, which were settled lower in the prior year period.”

The analysts’ comments suggest Cleveland-Cliffs’ record revenue will continue unabated. 

However, its earnings in the second quarter missed the consensus estimate by 8 cents. The company has now missed the consensus estimate in three consecutive quarters. The same thing may happen in the third quarter. 

Should that happen, you’ll likely be able to buy CLF stock in the teens, well below where it’s currently trading. 

My suggestion: If you like the company’s transformation, buy half a position now, and wait for it to report Q3 2021 results sometime in October. I would tread carefully. Its debt remains significant. 

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.