| May 1, 2023 One of the Most Unique Setups I've Ever Seen... My favorite commodity stock in 2021 became one of my leading ideas in 2022. And it’s still near the top of my list. Even after growing revenue by more than 10X these past few years, increasing EBITDA and free cash flow, and paying down debt, it remains unloved by the market. But the fact remains that it has one of the most unique setups I’ve ever seen… It also has a CEO with skin in the game—one of my no-brainer “shortcuts” for finding stocks with huge upside. And based on his remarks on the company’s first-quarter 2023 conference call, he’s looking to own more: “I’m going to buy a lot of stock as soon as the window opens.” That’s what I like to hear: Strong insider ownership bodes well for a company’s long-term upside potential. It’s part of the reason why I’m still so bullish on Cleveland-Cliffs Inc. (CLF)—a name longtime readers of Smart Money Monday likely will recognize. While it’s already made the leap from a subpar business to a high-quality, vertically integrated steel producer, I anticipate 2023 will be its breakout year once investors realize what renegade CEO Lourenco Goncalves has created. Where CLF Stands After Q1 EarningsCliffs put up a solid first quarter in 2023. It grew EBITDA nearly 100% compared to the fourth quarter of 2022. This was driven off strong price increases and demand from its customers. Cliffs expects EBITDA to continue growing throughout the year, but unlike many capital-intensive businesses, Cliffs converts this EBITDA into free cash flow. For 2023, I suspect the company will generate somewhere in the range of $1.5 billion in free cash flow after interest expenses and capital expenditures. Looking at today’s market cap of $7.7 billion, that implies Cliffs is trading at just 5X 2023 free cash flow. That’s way too cheap, which is great for us. I like cheap. What I really love, though, is cheap with a growth catalyst. Fortunately for Cliffs, the catalyst is right on the horizon… Smart Capital AllocationAs I mentioned, Cleveland-Cliffs is run by CEO Lourenco Goncalves. I’ve written about Lourenco several times. I think he’s incredibly underappreciated as an operator, capital allocator, and as someone with the ability to see the future of the steel market. As it pertains to capital allocation this year, Cliffs has been explicit: A significant portion of free cash flow will be used to pay down debt. The company is sitting on around $4.5 billion in debt as of the end of Q1 2023. By the end of the year, it forecasts that number dropping to $3 billion. When a company uses its cash to pay down debt, the value accretes to the equity. It’s the same logic with a house. A $1 million house with a $1 million mortgage has no equity value to you, the owner. If you pay down that mortgage, your net worth—your equity value—goes up. The same thing applies to businesses. In 2023, Cleveland-Cliffs is a debt pay-down story. And in late 2023 or early 2024, expect to see Cliffs’ catalyst start to hit. Cliffs Will Force Its Valuation HigherThe market clearly doesn’t give Cliffs much credit. Again, it’s valued at just 5X free cash flow. The problem, if any, with Cliffs is that it doesn’t pay a dividend. Personally, I don’t care about that. But Wall Street’s institutional investors do. Peers such Nucor Corp. (NUE), Steel Dynamics Inc. (STLD), and United States Steel Corp. (X) all pay out a dividend. I suspect Cliffs will begin paying dividends once it gets debt to that $3 billion figure. Going back to free cash flow, Cliffs should generate something like $1.6 billion in free cash flow once the debt gets to $3 billion. Less debt means less interest expense. Rough math here, but let’s assume it chooses to pay out 50% of this as a dividend. An $800 million dividend pencils out to around $1.50 per share. Today, Cliffs trades at $15. That implies a juicy 10% dividend yield. But let’s be super conservative: At a 5% dividend yield, Cliffs’ shares would be worth $30—a clean double from here. That’s how I’m starting to look at Cliffs from this point. The market won’t give the company any credit or real valuation. So, Cliffs is effectively going to force the valuation higher through steady cash dividends. Tying it all together, Cleveland-Cliffs Inc. (CLF) is still a buy here when you combine its strong insider ownership, current valuation, debt pay-down story, and potential dividend payments. Thanks for reading, —Thompson Clark
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Thompson Clark is a small-cap expert and value-focused investor with nearly a decade of experience in financial publishing. Thompson graduated from the Goizueta Business School at Emory University in 2010 with a focus in finance and accounting. He lives in North Carolina. He is the editor of Mauldin Economics’ free research service, Smart Money Monday. |
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