Cleveland-Cliffs (NYSE:CLF) has been making solid progress on its fundamentals. Bullish commodities market has pushed the profits higher. The stock is still an excellent long-term investment as I expect the bullish sentiment in commodities market to continue. Rising commodity prices will allow the company to grow its profitability, reduce leverage and enhance its financial position. As the favorable industry trends translate into higher profits, the stock price will also rise.
I have analyzed the financial position of the company, and the growth in profitability is clearly visible. As I expected, the debt levels have also come down, which has improved the credit profile. However, we are still at the start of the upcycle in the metals prices. As prices rise and consolidate, miners will benefit further. The image below shows the margins and leverage along with the trends in these metrics. Two quarters of 2017 have been added for comparison in margins. Effect of the improvement in profitability over the last two quarters and a decrease in debt will be explained separately.
Data Sourced from SEC Filings
Gross margin has been rising steadily and it has now reached over 18%. In the most recent quarter, this figure has gone over 25%. For the operating margin, I have adjusted operating expenses for non-core expenses. Some of these expenses were one-time charges like impairment. For this analysis, operating expenses only include core recurring expenses. Operating margin has followed the trend in gross margin and in 2016, it went into doubles digits. Operating margin of close to 13% is impressive, and it has more than doubled in the last three years. Second-quarter 2017 operating margin is over 20%. If the trend continues for the next two quarters, Cliffs’ profitability will make a substantial jump.
Net income for this analysis does not show the impact of non-core income and charges. The net margin has also more than doubled from 2014 to 2016. Net margin of over 20% in the second quarter of 2017 might not hold in the next quarters. The provision for taxes was extremely low in this quarter. A net margin of 15% is a fair representation of company’s profitability. However, even if the net margin only reaches 15% for the full year, it will be a considerable jump.
EBITDA had been falling due to the poor market conditions. As a result, leverage ratio had gone over 9x in 2015 but it fell to just over 6x in 2016. In my previous article (link provided at the end of the article), I predicted the leverage ratio to fall to around 4x by the end of the year. The reason behind this prediction was the prospect of an increase in EBITDA and a possible decrease in long-term debt. I predicted that the leverage ratio will fall to around 4x if the debt reduction is in the range of $400-500 million. At the end of the second quarter, the long-term debt stood at just over $1.6 billion, down from $2.175 billion at the end of 2016.
The reduction in debt is even higher than my expectations and leverage ratio now will be in the range of 3x by the end of the year. First half 2017 EBITDA is over $241 million. Similar performance in the next two quarters will give us full year EBITDA of around $500 million. At these levels, leverage ratio will be close to 3.2x. This is a much more respectable leverage ratio for a mining company. Cash flows generation has also improved (last quarter’s negative operating cash flows ($25 million) were mainly due to an inventory charge of $70 million). Second quarter operating cash flows were over $93 million. This improvement in fundamentals and credit profile was recognized by Moody’s at the end of July when the agency decided to upgrade the company’s senior unsecured rating to B2 from B3.
Efficient management of debt has also resulted in lower interest expense and higher operating margin. At the moment, the company’s debt maturities have been pushed back. Leverage has come down and the interest expense has also been reduced. Internal measures are also being supported by favorable commodities prices. The company is well-positioned to benefit further if the commodity prices continue to rise. It is an excellent long-term investment.
Please follow this link to read my previous articles about the stock.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.