Aging Assets And Global Overcapacity Will Crush Steel Margins

Key Takeaways

• Structural shifts toward steel recycling and decarbonization threaten core demand and pricing power, tightening revenue streams and margins.
  
• High capital demands, reliance on legacy assets, and industry disruption risk compressing profitability even as optimization benefits plateau.
  
• Favorable tariffs, domestic production trends, vertical integration, cost optimization, and a premium product focus are strengthening the company's margins, cash flow, and growth prospects.

Catalysts

Operates as a flat-rolled steel producer in the United States, Canada, and internationally.

• The company's future revenue growth is at risk due to a global push for increased steel recycling and circular economy adoption, which can structurally lower demand for newly-mined iron ore and primary steel-putting persistent pressure on Cleveland-Cliffs' core production volumes and top-line sales.
  
• The accelerating pace of decarbonization and transition away from fossil-fuel infrastructure across North America and globally is expected to dampen long-term demand for traditional steel products, eroding price premiums and resulting in both shrinking revenue streams and lower operating margins.
  
• Cleveland-Cliffs' high capital intensity and aging asset base require continual investment and maintenance, likely compressing free cash flow and net margins over time, especially as cost reductions from optimization initiatives reach their natural limits and large-scale upgrades or relines become unavoidable.
  
• Heavy reliance on domestic automotive manufacturers as a customer base increases exposure to cyclical downturns and technological disruption, particularly from electric vehicle trends that could reduce steel usage per vehicle or shift material needs, potentially driving down both volumes and profitability.
  
• Increasing global electric arc furnace (EAF) capacity and growing international steel overcapacity are expected to intensify price competition, undercutting Cleveland-Cliffs' pricing power and resulting in structurally depressed profit margins even if the U.S. maintains protectionist tariffs in the near term.

Cleveland-Cliffs Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Cleveland-Cliffs compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Cleveland-Cliffs's revenue will grow by 4.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -9.0% today to 2.6% in 3 years time.
• The bearish analysts expect earnings to reach $556.8 million (and earnings per share of $1.04) by about July 2028, up from $-1.7 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 7.9x on those 2028 earnings, up from -3.3x today. This future PE is lower than the current PE for the US Metals and Mining industry at 23.2x.
• Analysts expect the number of shares outstanding to grow by 6.39% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.88%, as per the Simply Wall St company report.

Cleveland-Cliffs Future Earnings Per Share Growth

Risks

• Persistent and enforceable Section 232 tariffs on imported steel and vehicles are significantly reducing foreign competition, supporting domestic steel prices and volumes, which could provide long-term revenue and margin tailwinds for Cleveland-Cliffs.
  
• Strong evidence of reshoring trends and OEMs moving automotive production and steel sourcing back to the United States suggest sustained higher steel volumes and improved capacity utilization for Cleveland-Cliffs, potentially lifting earnings and operational leverage.
  
• The company's successful vertical integration, especially after acquiring Stelco and bringing coke production in-house, is driving substantial cost reductions and improving EBITDA margins, positioning Cleveland-Cliffs with lower, more stable input costs and stronger free cash flow.
  
• Ongoing footprint optimization, rigorous cost-cutting, and noncore asset sales are releasing capital and reducing net debt, which is likely to enhance financial flexibility and support long-term profitability.
  
• Cleveland-Cliffs' focus on premium products such as bright annealed stainless steel for high-end automotive and appliance markets, combined with its unique relationships with automotive OEMs, creates opportunities for higher-margin sales and diversified revenue streams, which can support growth in earnings over time.

Valuation

• The assumed bearish price target for Cleveland-Cliffs is $5.56, which represents two standard deviations below the consensus price target of $10.47. This valuation is based on what can be assumed as the expectations of Cleveland-Cliffs's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $14.0, and the most bearish reporting a price target of just $5.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $21.1 billion, earnings will come to $556.8 million, and it would be trading on a PE ratio of 7.9x, assuming you use a discount rate of 9.9%.
  
• Given the current share price of $11.27, the bearish analyst price target of $5.56 is 102.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.