Acquisition Of Stelco Will Optimize Cost Structure And Emphasize Spot Sales

Key Takeaways

• The acquisition of Stelco is projected to boost Cleveland-Cliffs' net margins and earnings through improved cost structure and spot sales emphasis.
  
• Reducing capital expenditures and securing better coal contracts should enhance cash flow, net margins, and profitability.
  
• Dependency on the automotive sector and high interest rates may lead to reduced revenues, compounded by strategic project delays and unresolved industry trade pressures.

Catalysts

Operates as a flat-rolled steel producer in North America.

• The acquisition of Stelco is expected to average up the overall EBITDA margin of Cleveland-Cliffs due to Stelco's best-in-class cost structure and emphasis on spot sales. This could improve net margins and bolster earnings.
  
• The company anticipates generating $120 million of cost synergies within the first year post-acquisition of Stelco, which should enhance net margins and profitability.
  
• Cleveland-Cliffs is taking a lean approach to capital expenditures with plans to reduce its CapEx to $600 million for 2025. This could improve cash flow and net margins, potentially leading to higher earnings.
  
• Improved coal supply contracts are expected to provide a $70 million cost improvement year-over-year. This should positively impact net margins and earnings.
  
• The company is optimistic about a strong 2025 due to factors such as falling interest rates, manufacturing onshoring, and the execution of strategic growth projects, which are expected to drive revenue growth.

Cleveland-Cliffs Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Cleveland-Cliffs's revenue will grow by 4.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from -2.3% today to 6.2% in 3 years time.
• Analysts expect earnings to reach $1.4 billion (and earnings per share of $0.64) by about January 2028, up from $-461.0 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 27.2x on those 2028 earnings, up from -10.8x today. This future PE is greater than the current PE for the US Metals and Mining industry at 15.6x.
• Analysts expect the number of shares outstanding to grow by 64.7% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.92%, as per the Simply Wall St company report.

Cleveland-Cliffs Future Earnings Per Share Growth

Risks

• The company's dependency on the automotive sector implies that continued weakness or volatility in automotive demand could lead to decreased revenues and narrower profit margins, especially when fixed costs become harder to offset in slow periods.
  
• High interest rates are affecting consumer behavior, particularly in the automotive and housing markets, which could suppress demand for steel products and result in reduced revenues and earnings.
  
• The decision to idle a blast furnace due to weak demand and pricing pressures indicates potential ongoing challenges in meeting revenue targets and maintaining optimal production efficiency.
  
• Any delays in strategic projects like those at Middletown, Butler, and Weirton could defer the anticipated $600 million EBITDA contributions, potentially impacting future earnings projections.
  
• The steel industry faces risks from imports and dumping practices, and while protective measures are discussed, unresolved trade tensions or failure to address these issues could pressure prices and reduce competitive margins.

Valuation

• The analysts have a consensus price target of $13.45 for Cleveland-Cliffs based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $21.0, and the most bearish reporting a price target of just $8.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $22.6 billion, earnings will come to $1.4 billion, and it would be trading on a PE ratio of 27.2x, assuming you use a discount rate of 8.9%.
• Given the current share price of $10.05, the analyst's price target of $13.45 is 25.3% higher.
• 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.