This steelmaker is using strong results to repair its balance sheet
Cleveland Cliffs (CLF 2.06%) changed stripe in 2020 with the acquisition of AK steel, a former client. The move was a major overhaul, transforming Cleveland-Cliffs from a supplier to the steel industry to an integrated steel mill. Only it came at a high cost in the form of skyrocketing leverage. Management is using the recovery in the steel industry to do something about it.
A Debt Timeline
Between the start of 2020 and the first quarter of 2021, Cleveland-Cliffs’ long-term debt increased by 240%. There were two big jumps during this period, one in early 2020 and another in late 2020 that continued into early 2021. These moves coincided with Cleveland-Cliffs’ acquisitions of AK Steel and the US operations of the global steel giant. ArcelorMittal.
It was not a minor change. The company completely reinvented itself in about two years. Today, Cleveland-Cliffs is an integrated North American steel giant with a heavy blast furnace footprint. Blast furnaces aren’t as flexible as newer mini arc crushers, but when operating at high utilization levels they can be extremely cost effective. And with Cleveland-Cliffs controlling some of its key input costs, to some extent it has an added cost advantage in the industry.
But, to make this transition, the company’s debt levels turned out to be far behind those of its peers. For example, in 2020, Cleveland-Cliffs’ debt-to-equity ratio was six times huge, compared to less than 1.5 times for Steel in the United States (X 1.48%) and less than 0.8 times for both Nucor (NUDE 1.78%) and steel dynamics (STLD 1.68%). In some ways, the Cleveland-Cliffs acquisitions, including AK Steel, appeared to be trying to rescue key customers who faced heavily leveraged balance sheets at a time when the steel industry was weak.
Since that peak, Cleveland-Cliffs’ debt ratio has steadily declined, thanks at least in part to strong earnings. Today, its debt-to-equity ratio is just under 0.7x, still higher than its peers in the steel industry, but much closer to the roughly 0.4x or so that US Steel, Nucor and Steel Dynamics.
Put money for good work
In addition to strong recent results, Cleveland-Cliffs has also actively sought to strengthen its balance sheet through debt reduction, essentially putting cash from the current market rally to work. Notably, the company’s long-term debt levels have decreased by approximately 18.5% since the start of 2021. Management has a clear focus on debt reduction after increasing its leverage to to be able to quickly change its economic model.
However, there is a cost to this effort. For example, in the second quarter, debt reduction costs were $0.13 per share. This was the largest one-time item in the quarter, which recorded $0.18 of these one-time costs. If the debt reduction had not taken place, earnings would have been about 10% higher. That’s quite a significant difference. Given the still high debt ratio relative to its peers, the company’s debt reduction efforts are likely not yet complete either.
In fact, even after the debt reductions that have been made so far, the company’s long-term debt is still about 120% higher than it was before its steel acquisitions. Obviously, he can handle more leverage now that he has a bigger company, but with a leverage ratio of 0.7 when peers are closer to 0.4, management can’t yet s ‘Stop. Fortunately, the cyclical steel industry has recently benefited from strong demand and prices, so Cleveland-Cliffs was able to move quickly on the balance sheet front. That tailwind will likely continue for at least a little longer, but hitting while the iron is hot shows noticeable handling resolve.
Turning skeptics into believers
When Cleveland-Cliffs began to become an integrated steel mill, the level of debt it was carrying was frightening considering AK Steel’s financially weak state at the time. However, Cleveland-Cliffs appears to have timed this move well, and now that it is reducing debt, it is getting back in line with its peers on key financial metrics. There is still work to be done, but so far management seems to have made this transition very successfully.