Cleveland Cliffs (CLF 2.48%) changed its stripes in 2020 with the acquisition of AK Steel, a former customer. The move was a major reorganization that took Cleveland-Cliffs from a steel subcontractor role to an integrated steel mill. Only this came at a high price in the form of exploding leverage. Management is using the upswing in the steel industry to do something about it.
A timeline of debt
Between early 2020 and the first quarter of 2021, Cleveland-Cliffs’ long-term debt grew a whopping 240%. There have been two major jumps in this span, one in early 2020 and one in late 2020 that continued into early 2021. These moves coincided with Cleveland-Cliffs’ acquisition of AK Steel and the global steel giant’s US operations ArcelorMittal.
This was no small change. Within about two years, the company has completely reinvented itself. Today, Cleveland-Cliffs is an integrated North American steel giant with a strong blast furnace base. Blast furnaces aren’t as flexible as newer arc mini-mills, but when run at high loads, they can be hugely profitable. And because Cleveland-Cliffs controls some of its key input costs to some degree, it has an added cost advantage in the industry.
But to make that transition, the company’s leverage level fell well below that of its competitors. In 2020, for example, Cleveland-Cliffs’ debt-to-equity ratio was a whopping 6x, compared to less than 1.5x for United States steel (X 3.33%) and less than 0.8 times for both Nukor (NEW 1.49%) and steel dynamics (STLD 3.04%). In a way, Cleveland-Cliffs’ acquisitions, particularly AK Steel, looked like the company was trying to bail out key customers struggling with heavily indebted balance sheets at a time when the steel industry was weak.
From that peak, Cleveland-Cliffs’ debt-to-equity ratio has steadily declined, thanks at least in part to solid earnings. Today, its debt-to-equity ratio is a little under 0.7 times, still higher than its steel industry peers but much closer to about 0.4 times that of US Steel, Nucor and Steel Dynamics.
use money for good work
In addition to strong recent results, Cleveland-Cliffs has also actively sought to strengthen its balance sheet through deleveraging, essentially to take advantage of cash flow from the current market upturn. Notably, the company’s long-term debt has fallen by around 18.5% since the start of 2021. Management is clearly focusing on deleveraging after increasing leverage so it can quickly change its business model.
However, this effort is associated with costs. For example, the cost of deleveraging in the second quarter was $0.13 per share. This was the largest non-recurring item in the quarter, with such non-recurring charges of $0.18. Without the deleveraging, earnings would have been around 10% higher. That’s a pretty significant difference. Given the company’s still high leverage relative to its peers, the company’s deleveraging efforts likely aren’t over yet.
In fact, even after deleveraging to date, the company’s long-term debt is still around 120% higher than it was before the steel acquisitions. It’s clear that now that it has a bigger business it can handle a larger debt load, but with a gearing ratio of 0.7 when the competition is closer to 0.4, management can’t stop just yet. Fortunately, the cyclical steel industry has recently benefited from strong demand and pricing, allowing Cleveland-Cliffs to act quickly on the balance sheet front. That tailwind is likely to continue for a little longer, but a hit while the iron is hot shows remarkable management resolve.
Turn skeptics into believers
When Cleveland-Cliffs first embarked on the path to becoming an integrated steel mill, the level of debt was staggering given AK Steel’s financial weakness at the time. However, Cleveland-Cliffs appears to have timed the move well, and now that it’s deleveraging, it’s bringing itself back in line with its peers on key financial metrics. There is still work to be done, but so far it looks like management has made this transition with great success.