What happened
Shares of iron ore producer and steelmaker Cleveland-Cliffs (CLF +3.47%) fell roughly 10% by noon EDT on June 18. That follows a relatively smaller loss the day before and a material price increase on June 16, driven by rumors that the White House was looking to introduce a large infrastructure spending program. That said, there was no particular news today from the company.
So what
The trepidation that investors were showing likely relates to a bad day of news for peer United States Steel (X +0.00%). First, on June 17, the iconic steel maker announced its second-quarter earnings would be much worse than industry watchers were expecting. Then, after the close, U.S. Steel announced that it was selling roughly 50 million shares of stock in an effort to shore up its balance sheet. That led to two days of losses for U.S. Steel's stock.
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But there's a connection here that's very important. Both Cleveland-Cliffs and U.S. Steel make heavy use of blast furnaces. Although important in making primary steel, these are larger and less flexible than the more modern electric arc mini-mills that underpin the operations of competitors like Nucor and Steel Dynamics. Furthermore, like U.S. Steel, Cleveland-Cliffs has a debt-heavy balance sheet. To put a number on that, Cleveland-Cliffs' financial debt-to-EBITDA ratio is roughly five times compared to about two times for both Nucor and Steel Dynamics. In the most recent quarter it covered its trailing interest expenses around 3.2 times over, while Steel Dynamics was at nearly eight times coverage and Nucor 10.5 times.
Additionally, Cleveland-Cliffs just issued $120 million in new debt at an interest rate of 6.75%. That's relatively high given the historically low interest rate environment. The cash is being used to pay down a revolving credit facility and to help fund capital investment plans. Although the cash is needed, it simply means that leverage is going up, not down. All in, as investors are growing more concerned about U.S. Steel's future, because of its blast furnace focus and leverage issues, they've also grown more concerned about Cleveland-Cliffs' future.
Now what
The tap-on effect here makes complete sense, given the rough similarities between U.S. Steel and Cleveland-Cliffs. It's not unreasonable to expect that Cleveland-Cliffs will offer up disappointing news when it reports second-quarter results based on U.S. Steel's warning. And neither company is likely to get out from under their debt-heavy balance sheets anytime soon. Long-term investors looking at the steel space would be better off considering alternatives like Nucor and Steel Dynamics.
