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2019-07-22 08:23:07

Cleveland-Cliffs (CLF) released its Q2 2019 financial results. As expected, the numbers were much better compared to Q1, as Q1 is traditionally Cleveland-Cliffs' weakest part of the year due to the negative impacts of winter weather. However, in Q2, the company was able to beat also the analysts' estimates.

The company produced 5.177 million long tons of iron ore, which is notably more than in Q1 2019 but 6% less compared to Q2 2018 (chart below). Iron ore sales climbed to 6.227 million long tons, which is 4.3% above the Q2 2018 levels. The resulting revenues equaled $747.2 million, which means a 4.3% improvement to Q2 2018.

Source: own processing, using data of Cleveland-Cliffs

Although revenues were good in Q2, the costs of goods sold are a little disappointing. They equaled $70.15/long ton, which means an 8% growth year-over-year (chart below). The increased costs had a negative impact on Cleveland-Cliffs' incomes. Operating income was $226.8 million, which is better than in Q3 and Q4 2018 and obviously also than in Q1 2019, however, it is 8.5% worse than in Q2 2018. Adjusted EBITDA provides a similar picture, as this number stands at $248.5 million, which is almost 10% below the Q2 2018 value.

Source: own processing, using data of Cleveland-Cliffs

Q2 2019 net income climbed to $160.8 million, which is comparable to Q2 2018 (only 2.6% below the Q2 2018 level). Although the chart below shows that the Q2 net income is much lower than in Q3 and Q4 2018, it doesn't mean any serious issues, as Q3 and Q4 results were very positively affected by items such as income tax benefits. Q2 EPS equaled $0.59. Although net income was lower compared to Q2 2018, the EPS increased by 7%, which is a positive impact of the share-buyback program that led to a reduction of outstanding shares from 297.618 million to 270 million as of the end of Q2 2019.

Source: own processing, using data of Cleveland-Cliffs

Cash & cash equivalents held by Cleveland-Cliffs declined slightly in Q2 2019 (chart below). The company ended Q2 with a cash balance of $377.2 million. The decline was caused by the continuing investments in the new Toledo HBI plant as well as the continuing share-buyback program. Under the share-buyback program, Cleveland-Cliffs repurchased 13 million shares for $129 million. Long-term debt of the company experienced a negligible increase to $2.105 billion. As a result, the net debt grew to $1.727 billion. The debt is high but given that Cleveland-Cliffs is able to generate an annual EBITDA in the $700-800 million range, it is definitely manageable, assuming that the current iron ore prices prevail. Moreover, next year, Cleveland-Cliffs will start production of HBI (Hot-Briquetted Iron) which should elevate the annual EBITDA above the $1 billion level.

Source: own processing, using data of Cleveland-Cliffs

The company seems to be optimistic regarding future developments. According to Lourenco Goncalves, Cleveland-Cliffs' CEO:

The New Normal in the global iron ore market has started to influence our results, offsetting weak steel prices in the United States during the second quarter. While the New Normal in iron ore is here to stay, the absurdly low prices for steel in the United States are just a temporary thing, and we should see higher steel prices going forward. On top of that, our Toledo plant construction is ahead of schedule, and we now expect to be producing HBI in less than one year.

Especially the information about the Toledo plant construction being ahead of schedule is positive. After it starts producing HBI, Cleveland-Cliffs will not only start to sell a premium product, boosting the profit margins, but the capital expenditures will decline significantly, providing a lot of space to quicken the debt reductions, increase the share-buyback program or increase dividends.

However, there is also a slightly more negative piece of news related to the Toledo plant. Cleveland-Cliffs increased the estimated 2019 capital expenditures from $555 million to $650-700 million:

Cliffs now expects to reach commercial production at its Toledo HBI plant ahead of schedule, in the first half of 2020. Due to the advanced construction timeline and more certain visibility of the start-up date, a portion of the budgeted contingency has been allocated. As a result, Cliffs' 2019 total capital expenditures expectation was revised to $650-$700 million. There is no change to the base budget of the HBI project.

From a technical point of view (chart above), the situation is unclear. The quicker moving average has been closely oscillating around the slower one lately. Although a long-term support line still holds, a new line of resistance was created over the last 9 months. Right now, the share price is moving in a triangle pattern, close to its upper boundary. If this resistance is broken, the next one is around $13, the peak reached during last September. After the $13 level is broken, the road should be clear up to the $17.5 area. On the other hand, if the current resistance holds, the share price may re-test the support in the $9-10 area. The RSI stands just below the level of 60, which leaves a lot of space for the share price to grow before the overbought territory is reached. However, over the last two years, Cleveland-Cliffs' shares approached the RSI level of 60 five times. And only one attempt was successful and led to a continuation of the share price growth.

Conclusion

Cleveland-Cliffs experienced a successful Q2. The EPS climbed to $0.59 and if similar results are reached also in Q3 and Q4, the overall 2019 EPS will be $1.69. It means that at the current share price of $11.09, Cleveland-Cliffs' P/E ratio would be only 6.56, which is a very low value for a company generating a lot of cash, working on an important development project and operating in a safe jurisdiction. However, from a technical point of view, it is not clear whether the share price will go up or down in the near term. Everything will depend on the ability to overcome the resistance levels in the $11 and $13 area. If they are broken, the road to $17.5 is clear. If not, the share price may try to re-test the support in the $9-10 area.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CLF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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