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Cleveland-Cliffs Debt Extinguishment Costs Cover Up Impressive Quarterly Results

By Tyler Crowe – Oct 20, 2017 at 3:17PM

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Another round of refinancing to lower interest payments hit the bottom line, but it should pay off down the road.

You might not be able to tell from Cleveland-Cliffs' (CLF 2.25%) stock performance over the past couple of years, but the company has made incredible strides in improving the balance sheet and building the business into a profitable operation again. Those results during this recent quarter showed up in the bottom line.

Let's sift through Cleveland-Cliff's most recent earnings results and see why investors may want another look at this stock.

Iron ore loading facility

Image source: Getty Images.

By the numbers

Metric Q3 2017 Q2 2017 Q3 2016
Revenue $698.4 million $569.3 million $553.3 million
Operating income $129.7 million $114.6 million $34.7 million
Net income $53.4 million $31.8 million ($25.8 million)
EPS $0.18 $0.11 ($0.12)

Data source: Cleveland-Cliffs earnings release. EPS = earnings per share.

Like the prior quarter, Cleveland-Cliff's results were split between its domestic and international operations. Its U.S. iron ore segment continued to improve as the company maintained low costs and was able to realize a per-ton price of $90. That's not too shabby for an industry that many have left for dead for a while. 

Its Asia-Pacific operations continue to be a trouble spot, though. The per-ton sales margin dropped to just $1.34, which was a result of lower production volumes and higher per-ton costs that needed to be spread around a smaller production base. This part of the business has been struggling for quite some time, which is why management isn't putting any money into the facility and plans to sunset the facility once it is no longer a cash flow-generating asset. 

These results are also impacted by an $88 million noncash charge related to an early debt extinguishment. Without those costs, results would have been much better. 

CLF Adjusted EBITDA by business segment for Q3 2016, Q2 2017, and Q3 2016. Shows modest decline for Asia Pacific iron ore more than offset by U.S iron ore.

Data source: Cleveland-Cliffs earnings release. Chart by author.

This year has been about putting the company back on a more solid financial footing, and this past quarter it did some more financial wheeling and dealing. It paid back all of its 2020 senior notes outstanding with the issuance of $575 million in new notes due 2025, and took an $88 million charge on the early extinguishment of debt. However, the deal will be worth it in the long run as the new notes carry with them an interest rate of 5.75% compared to the 8.25% it was paying on the now-retired debt. At the end of the quarter, Cleveland-Cliffs had $1.43 billion in net debt. 

The other notable major event this past quarter was the company's purchase of the remaining interest in its Tilden Mine from United States Steel for $105 million in cash. Management said at the time that it would give it more flexibility to invest in the mine and to increase overall production that can feed its planned Hot Briquetted Iron (HBI) facility in Toledo, Ohio. 

What management had to say

Cleveland-Cliffs CEO Lourenco Goncalves' statement on the quarter was upbeat as he talked about the two deals he and his management team made. He said: 

We are very pleased with our accomplishments so far this year, in which we became a much more profitable company, substantially improved our debt profile and now pay a lot less in interest expense. With the third quarter numbers in the books, we have already outperformed in three quarters of 2017 the results of the entire 2016. On top of that, during the third quarter, we acquired the remaining 15% of the Tilden Mine, and now own 100% of all active and idled iron ore mining assets in the State of Michigan. The acquisition will allow us to become a 20 million long ton pellet supplier in 2018.

What a Fool believes

Cleveland-Cliffs is likely putting the finishing touches on the turnaround plan that Goncalves laid out a few years ago. With the refinancing of its debt, it now has a much lower interest expense with extended maturities that puts it a long way away from the financial troubles it was facing before his arrival.

CLF Chart

CLF data by YCharts.

At the end of the prior quarter, management was guiding for annual adjusted EBITDA of $650 million. After this most recent quarter, that doesn't seem likely. It would require a blowout quarter that would have to come almost entirely from higher prices since management already expects to sell 1 million tons less iron ore than initially anticipated. 

That said, the company is in much better shape than it has been in years, and its outlook appears very good. If Cleveland-Cliffs can maintain the same pace it did this quarter, then shares look quite cheap. 

Tyler Crowe owns shares of Cleveland-Cliffs. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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