Cleveland-Cliffs Inc. (NYSE:CLF) Q4 2023 Earnings Call Transcript

Cleveland-Cliffs Inc. (NYSE:CLF) Q4 2023 Earnings Call Transcript January 30, 2024

Cleveland-Cliffs Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen. My name is Mellisa, and I am your conference facilitator today. I would like to welcome everyone to Cleveland-Cliffs’ Full-Year and Fourth Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. The company reminds you that certain comments made on today’s call will include predictive statements that are intended to be made as forward-looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially.

Important factors that could cause results to differ materially are set forth in reports on Forms 10-K and 10-Q and news releases filed with the SEC, which are available on the company’s website. Today’s conference call is also available and being broadcast at clevelandcliffs.com. At the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss results excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published yesterday. At this time, I would like to introduce Celso Goncalves, Executive Vice President and Chief Financial Officer.

Celso Goncalves: Good morning, everyone. Before discussing our 2023 results, I’m going to start this call by briefly addressing our recent involvement in the U.S. Steel sale process. And then I’ll clarify our M&A strategy and capital allocation priorities going forward. Just so everyone’s on the same page, Cleveland-Cliffs is referenced as company D as in Delta in the proxy statement filed by U.S. Steel last week on December 18 2023 U.S. Steel announced its intention to sell the entire company to Nippon Steel of Japan and indicated their expectation to close the transaction by Q2 or Q3 of 2024 following a brief customary regulatory review process that was characterized by the U.S. Steel CEO as having “a low level of risk”.

As we all know by now these were just a few of many severe misjudgments made by the U.S. Steel Board, their management team, their lawyers at Milbank and Wachtel and their financial advisors at Barclays and Goldman Sachs. A deal is only a done deal when it closes and recent reports make it clear that their announced transaction with Nippon faces a very uncertain path to close. So their saga is not over. Cleveland-Cliffs is the only company with recent experience in successfully closing acquisitions involving USW represented iron and steel making assets. We did it twice in 2020 when we bought AK Steel and AM USA, one of which was a whole company transaction and the other of which was an acquisition of certain USW represented assets. M&A deals involving unionized labor forces are a completely different animal than cookie-cutters’ sale processes.

Labor agreements are not black and white and practical implications of upsetting the unions are hard to predict. Our acquisition track record proves that we act opportunistically on deals. We execute and close value accretive transactions that benefit all stakeholders involved. The final proposal from Cliffs to acquire U.S. Steel included $27 in cash, $27 in CLF stock, and over $6 in synergy value to U.S. Steel stockholders, combining for a total value of over $60 per share. The industrial logic of eclipse U.S. Steel combination goes without saying, and that’s the main reason we were willing to offer this value for the acquisition. There’s no other buyer that can deliver $750 million in cost synergies. Our offer provided the best value and future upside for investors in the combined company.

Our final proposal also included adequate remedies to mitigate antitrust regulatory risk and preserve a competitive market environment. Cleveland-Cliffs offered a clear path to close the transaction. But rather than working towards a deal with Cliffs, U.S. Steel chose to announce a proposed sale of the company to a foreign buyer with serious conflicts of interest for America, no support or even awareness from the union and for a lower overall value. U.S. Steel clearly overestimated the regulatory antitrust risk with Cliffs, completely ignored the union, and miscalculated the political risk with Nippon given the negative implications to our supply chains and national security. So given all of this, what is Cleveland-Cliffs planning to do about M&A and capital allocation going forward?

We’re going to do exactly what we always do. We’rе going to continue to be opportunistic on M&A. We’rе going to be buying back shares, and we’rе going to be paying down debt. In 2023, we generated more than $1.6 billion in free cash flow nearly $500 million of which came in the fourth quarter alone. We actually generated more cash in 2023 than we did in 2022 when our adjusted EBITDA was higher. We used most of this free cash flow to pay down debt last year, bringing our net debt down by $1.3 billion year-over-year to only $2.9 billion as of the end of 2023, below our stated target of $3 billion. We have a balance sheet that can withstand volatility in the field market, giving us flexibility to toggle capital allocation priorities as needed, based on the opportunities in front of us.

For now, we plan to be even more aggressive with share buybacks, given the discount presented in our stock. We still have over $600 million remaining in our existing share repurchase program and depending on market and other conditions we plan to deploy the remainder of this dry powder during open windows. And by the way as of today we have no MNPI and we are free to trade and buy our stock as soon as the window opens tomorrow. With that said, we will also continue to reduce our net debt. Over the past two years, we have allocated roughly 85% of our free cash flow to debt repayment. During this period, debt reduction was our number one capital allocation priority, with share buybacks and M&A opportunities explored opportunistically. Going forward, share buybacks are now the number one priority.

We have already paid off the entire balance of our ABL. This is a notable accomplishment that has brought our current liquidity above $4.5 billion, the highest level in our company’s history. Our debt reduction will now be executed primarily via open market bond repurchases and redemptions. From an operational standpoint, 2023 was another blockbuster year for Cleveland-Cliffs. We delivered record shipments both in total and specifically to the automotive industry. We reduced costs by $80 per ton in 2023 and generated $1.9 billion in adjusted EBITDA. With the successful negotiation of our coal and alloy supply agreements, the purging of higher cost inventory in 2023, lower natural gas hedges, and continued healthy operating rates, we expect to achieve another $30 per ton in cost reductions in 2024, equating to roughly $500 million in EBITDA increase just from these cost reductions.

In the fourth quarter of 2023, we generated adjusted EBITDA of $279 million, which we believe is the trough in quarterly adjusted EBITDA going forward. We reported our fourth consecutive quarter of shipments above 4 million tons, compared to 2022, in which all four quarters were below this level. We generated $487 million of free cash flow, affirming our prior commentary that working capital would be a meaningful source of cash for us in Q4. From an EPS standpoint, it’s important to note that we reported both GAAP and adjusted EPS for Q4. The adjusted EPS figure backs out a small, one-time, non-cash goodwill impairment related to our non-core tooling and stamping business, previously known as Precision Partners, which was a small company that AK Steel had bought before we acquired them in 2020.

Based on revised capital priorities and higher discount rates, we decided to write-off the goodwill value related to those non-core assets as we had foreshadowed in our 10-K. Our capital expenditures in 2024 should remain at similar levels as 2023, with an expected outflow of $675 million to $725 million for the full-year. I would note that this is by far the lowest amongst our peers with our equipment in very good shape and no plans to add any capacity. Our DD&A projection for 2024 is about $950 million, a decline from 2023. Our SG&A expense should be around $550 million, also a small decline from 2023. Furthermore, our automotive and other fixed contract pricing should remain in the same ballpark as 2023, which should actually promote some margin expansion due to our lower costs.

Finally, you should note that we have uploaded an earnings presentation to our website for the benefit of our investors. While we don’t plan to go through the slides during this call, we believe that you will find the materials to be a helpful reference to our financial highlights. Going forward, we plan to update this presentation each quarter for your convenience. With that, I will turn it over to Lourenco.

Lourenco Goncalves: Thank you, Celso, and we welcome everyone to this call today. We are very pleased with what we were able to accomplish in 2023. Our total shipments of 16.4 million tons clearly demonstrated what our operations are now capable of. For reference, in 2021, which was our first full-year under the current configuration. Even with demand off the charts for basically the entire year, we only did 15.9 million tons of shipments. And that was with one more blast furnace operating than we have right now. I’m also proud of the successful implementation of the Cliffs H surcharge, which applies to the steel we produce through the BF, BOF, route using HBI as feedstock in the blast furnaces. This is actually the only true green steel premium that exists in the marketplace.

With Cliffs H, we were able to implement a tangible way for us to be monetarily recognized for the real environmental gains and CO2 emissions reduction we have achieved over the last several years. With this success, we are pleased that we are able to hold our automotive pricing roughly steady into 2024, despite low-priced competition in the marketplace. Going forward, we expect a lot of progress over the next decade with emphasis on hydrogen. We have deployed $10 million to build a hydrogen pipeline on site in preparation for the hydrogen hub to be built in Indiana with funding from the Department of Energy Hydrogen Initiative. The pipeline is ready, and late last week, we initiated our second blast furnace hydrogen injection trial. On Friday 26, we inject H2 gas for over an hour into the two years at our Indiana Harbor number 7 blast furnace, the largest blast furnace in the Western Hemisphere, with great success.

The trial resumed yesterday when we injected the hydrogen at Indiana Harbor 7 for most of the day. The trial continues today. We are very excited with the positive results we have got so far on production, process control, quality of hot metal, and CO2 emissions. From the mineralogical standpoint, hydrogen as a blast furnace reductant works very well. Hydrogen is the real game-changing event in ironmaking and steelmaking, and that’s how our Cleveland-Cliffs pathway for the production of green steel. We appreciate the partnership Cleveland-Cliffs has with the Department of Energy, as well as with several other cabinet-level offices. Due to the efforts of the Biden Administration, and it’s very important to emphasize that by parts and supporting Congress, the United States is closer than anyone else to becoming the first country in the world to have abundant and competitively priced green hydrogen available to support a true green industrial revolution.

We are also grateful for our partnership with our gas supplier, Linde, in these efforts. Linde remains as committed to this technology as we are. Speaking of technology, American ironmaking and steelmaking technology is superior when compared to foreign steelmakers. Casing points, the CO2 emissions intensity of Cliff’s blast furnaces and DOFs are 25% to 40% better than the emissions associated to steel produced through similar equipment in Japan, Korea, China, or Europe. Said another way, none of the top 10 steelmakers in the world have better CO2 emissions profile than Cleveland-Cliffs, none. We are better than each one of them by a large margin. Our numbers are better because our technology is far ahead. Their so-called “decarbonization strategies” are things we have been doing at Cliffs for a long time and have perfected.

The use of our ore [Indiscernible], natural gas utilization as reductants. HBI used as feedstock in blast furnaces, and now hydrogen injection. In the United States, the Cliffs’ brand is synonymous with technology innovation and quality steel. We are the benchmark and the OEMs recognize that. Our technology got us our reputation and we will continue to be on the cutting-edge to ensure that this technological advantage stays with us. As for the broader market, we are, of course, pleased to see that each of our price increases announced over the last several months was successfully implemented after the market once again lost touch with reality in the August-September 2023 timeframe. The underlying basis to nearly all our strategic moves over the past decade has been the ongoing and inevitable increase in the tightness of ferrous scrap metal in the United States, particularly prime scrap.

In 2023, the Busheling scrap price averaged $490 per gross ton, a number about $100 higher than the prior decade average. After owning our scrap company FPG for more than two years, it’s now very clear to us that scrap is very valuable, particularly here in the United States. Keep in mind, the steel market in the United States is different from the rest of the entire world. Here more than 70% of the steel production uses EAFs and therefore a lot of scrap. Since we acquired FPG in November of 2021, we have been working to allow for the natural forces of supply and demand to prevail instead of settling for the power of an industry dominated by a couple of mega buyers of scrap. A lot of the so-called cyclicality of the steel business in North America is self-inflicted and caused by the strange ways scrap is transacted.

Once this serious issue is finally resolved, artificial seasonality will be eliminated and HRC prices can be stable for extended periods of time. Finally, as it’s now public, we were prepared to deliver $60.50 per share of value for U.S. Steel, well in excess of any other bidder, and with a cash and stock structure that their major stockholders told us they prefer over an all cash offer. Keep in mind, their major stockholders, they are a Delaware company, are also our major shareholders. We are a Ohio company. And we speak with them very frequently. Unfortunately, we could not deliver the superior value to the West Steel stockholders, because the West Steel board stood in the way and was hell bent to sell to a foreign entity. And despite what is written in their proxy statement, based on our substantive analysis of the antitrust risk, we were fully confident in our strategy to clear any regulatory risks.

We are truly disappointed for the U.S. Steel employees, particularly the unionized workforce. There is only one reason the USW exclusively backed Cleveland-Cliffs and assigned to us the right to bid. It’s our proven commitment to not just preserve, but to grow good American manufacturing jobs, good American middle class jobs, and maintain American ownership of industries critical to our national security and to our supply chains. Fortunately for the workforce, we do not believe that the final chapter of this story has been written. It’s now evident that the U.S. Steel Board of Directors made too severe miscalculations. They overrated the potential antitrust regulatory risk related to Cliffs, and they completely underappreciated the risks related to the CFIUS review and the USW union contractual rights.

We applaud the Biden administration for raising alarm bells on this proposed transaction. Along with influential elected officials at the Senate and at the House of Representatives on both sides of the aisle, the Biden administration has been very clearly expressing their views. We believe they rightfully see this transaction with Nippon as proposed, being bad for America and bad for American workers. As we all know, it’s hard to point out a single subject that can unify the positions and opinions of Democrats and Republicans. At this moment in time, it would be seen as a miracle. Well, the unforced error made by the West Steel Board of Directors was able to promote this miracle. That’s why we believe that the mistake will be fixed, hopefully earlier rather than later.

For now apart, we will continue to fight for our industry, for our company, our shareholders, and for the American workers. With that, I’ll turn it over to Melissa for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Lucas Pipes with B. Riley Securities. Please proceed with your question.

Lucas Pipes: Thank you so much, operator. Good morning, everyone. Lourenco, to go back to your U.S. Steel comments just a moment ago, I wanted to ask what gives you or gave you the confidence in the synergies, while also potentially having to meet divestiture requirements to clear antitrust? We really appreciate your perspective. Thank you.

Lourenco Goncalves: Yes, we had a package. Good morning, Lucas. We had a package that we — our attorneys at Dave’s Hawk were discussing with the attorneys at New Bank, that we believe would be more than sufficient to clear our regulatory hurdles. And that included the commitment to sell pellets to others, the commitment to sell labs to others, other commitments on supply agreements. And we would go all the way to some divestitures up to a level of $2 billion in revenues. That should do it, based on our own homework done with the — with our knowledge of the DOJ works, the antitrust division of the DOJ works, and our deep experience led by Howard [Indiscernible] of Dave’s Hawk. Unfortunately, we never had a willing partner, even though we were discussing in terms of working together.

We never had a willing partner with Milbank. And by the way, for the record, the $7 billion hurdle in revenues was never revealed to us. It was an internal discussion of U.S. It was just an internal discussion. It was never even discussed with us. So if they had brought that to the conversation, we would easily turn it down. So we are very, very confident on what we had done and all the homework we did. We don’t get the support we had from the administration, from political eminent, political figures on the left, on the right, on the center, and you know the names. And if I need to say the names to clarify what they have to do it. And that was totally ignored. So you absolutely, you have it what you saw. And at this point, we’ll see. Stay put.

Lucas Pipes: I appreciate the comment.

Lourenco Goncalves: [Multiple Speakers] I forgot to talk about synergies. Yes, you know, how we operate with synergies. We usually, we under promise and over deliver. That is what happened with the AK Steel. That’s what happened when we acquired Ascometal USA. So at this point, with the U.S. Steel would be more of the same, just in a bigger scale. So that would come from purchasing, that would come from services background, healthcare, renegotiations, all kinds of good stuff in terms of having a bigger footprint and a lot more ability to negotiate out of a much more broad type of footprint. And very importantly, our synergies were not anticipating that we would shut down any facility and would not be letting go any single union employee, any single worker at the plant of West Steel or Cleveland-Cliffs for that matter.

So that would not be cutting jobs, so I’ll leave it at that, but we had a robust proposal and they elected to go in a different direction. Good luck, like I said on December 18. Good luck on closing.

Lucas Pipes: Thank you. Thank you, Lourenco. I appreciate that color. In the meantime, many companies in the sector with strong cash flow have moved towards a kind of a formulaic approach to capital returns, allocating a percentage of available free cash flow to buybacks for example. You mentioned earlier kind of buybacks, debt reduction, and opportunistic M&A as kind of three areas of capital allocation, but I wondered if you would be prepared to move towards a percentage for example towards buybacks would appreciate your color. Thank you.

Lourenco Goncalves: Yes, Lucas, I’ll let Celso answer this one. Go ahead, go ahead.

Celso Goncalves: Yes. Hey Lucas. So as I stated, you know, we’ve in the prior quarters we’ve allocated about 85% of free cash flow to debt reduction. What we’re going to do going forward is we’re going to be flexible. We’re going to be a lot more aggressive with share buybacks. But you can sort of estimate that it will be sort of 50-50 buybacks and debt reduction. And the reason that we’re not putting in place a dividend at this point, for example, is because we want to remain flexible. There are a lot of M&A opportunities available, including the one that was announced in December. We don’t think that story is over yet. So I think staying with this 50-50 split, it gives us enough flexibility to toggle the priorities and be able to move quickly if opportunities present themselves.

Lucas Pipes: That’s very helpful. I really appreciate the color and to you and to team at Cliffs. Continue best of luck.

Lourenco Goncalves: Thanks a lot, Lucas [Multiple Speakers]

Celso Goncalves: Thank you, Lucas.

Operator: Thank you. Our next question comes from the line of Timna Tanners with Wolfe Research. Please proceed with your question.

Timna Tanners : Thank you. Good morning. I wanted to just clarify if I could some of the 2024 EBITDA colors, or sorry, the guidance that you gave about how we can use that to arrive at forecasts. So you’re talking about a little stronger volumes and I think $30 per ton of lower costs on a net basis. And then on the pricing side, obviously we could use the futures, we could have our own forecast, but I was hoping for a little bit more color on the comment about why you think prices shouldn’t go below a $1,000 given the futures market well below that. So just a little more color on making sure I have those numbers right on the futures, on the outlook, and also your thoughts on my comment on the $1,000.

Lourenco Goncalves: Good morning, Timna. Let me start with the futures. The futures are fiction because it’s done by desks that guys that if I show them a hot-rolled coil, a cold-rolled coil, galvanized coil, normal spangled, they still cannot differentiate one from the other and you know that. So they can go up and down $200, $250 per ton in a day. And they do that with absolutely no consequences. So that’s my opinion on futures. Basically, you can use that thing to a toilet paper, it’s useless. That’s the future. Because we have a few producers of hot rolled in the country. We deal every day with the thing. And we buy, we sell, we transact, we produce. And we know a lot more about the future than the future. So reset yourself, Timna.

Unplug yourself from the wall. Plug again, they’re going to be okay with pricing going forward. And then you’re not going to be talking about steel [Indiscernible] and things like that. Because I see potential in you. As far as the EBITDA guidance $30 per ton is basically the $500 million of the big data that you are talking about. If you multiply $30 bucks by 16.5 million tons of shipments, you get to 495. So I’m rounding up to 500. That’s the number.