Like many of its North American steel-making peers, Cleveland-Cliffs (CLF -1.24%) has been reporting impressive earnings over the last few quarters. However, there's the not-so-small issue of rising costs to contend with. Luckily, Cleveland-Cliffs has a tool at its disposal to deal with inflation.
Jumping into the steel industry
Cleveland-Cliffs was not a steel company until March 2020, when it bought AK Steel. It became an even bigger producer toward the end of 2020 when it completed the acquisition of ArcelorMittal's U.S. business. Those two transactions vaulted the company onto the leader board in the U.S. steel sector, along with peers Nucor (NUE -1.08%), Steel Dynamics (STLD -3.16%), and United States Steel (X -3.53%).
But there are important differences among these companies.
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For starters, Nucor and Steel Dynamics both make use of electric arc mini-mills. These tend to be more flexible than the older blast furnace technology that underpins the operations of U.S. Steel and Cleveland-Cliffs. That's worth keeping an eye on because blast furnaces tend to be highly profitable when they run at high usage rates, but can quickly turn unprofitable when demand falls off. Electric arc mini-mills, by contrast, can be ramped up and down more easily to adjust with the market and, thus, Nucor and Steel Dynamics tend to have more consistent results over time.
The next notable issue that should interest investors is what Cleveland-Cliffs did before it made steel.
Going vertical
Prior to 2020, Cleveland-Cliffs was a steel industry supplier, selling iron ore to the other mills, including those it purchased. In some ways, the buyout of AK Steel was something of an attempt to salvage an important business relationship, because that mill was struggling under a heavy debt load at the time it was bought. The addition of ArcelorMittal, though, really changed the game, as it proved that Cleveland-Cliffs was serious about entering the steelmaking business.
However, because it started as an industry supplier, what it basically created was a vertically integrated steel mill. It has notable control over its costs because of this, which is very important during an inflationary period. Essentially, as competitors buying iron ore from Cleveland-Cliffs have to swallow higher prices, Cleveland-Cliffs' costs will rise, too, but likely not as much. That should provide an edge that could support profits at a time when peers are feeling a pinch.
Cleveland-Cliffs isn't done with its business overhaul just yet. In late 2021 it bought a scrap metal company. This makes it a key supplier of another important input, this time the main support for electric arc mini-mills, which make heavy use of scrap steel. Again, the company is positioning itself to benefit from increasing prices of commodity products that go into the steelmaking process.
All of these acquisitions come with a cost, of course. Cleveland-Cliffs' debt-to-equity ratio of around 0.79 is nearly twice that of its U.S. peers, all of which are around 0.40. And yet Cleveland-Cliffs' debt-to-equity ratio has fallen notably as it has used the windfall from a strong steel market to strengthen its finances. That trend is likely to keep going and result in a much better-positioned company for the inevitable industry downturn, given the highly cyclical nature of the steel industry.
A complete overhaul
Cleveland-Cliffs is not the same company it was just a few years ago. But its evolution is notable because it has created a strongly integrated business that is also an industry supplier, providing the company what could be viewed as double protection from inflation. Although leverage is high, anyone looking at U.S. Steel, the company's primary competitor, would do well to take a closer look at Cleveland-Cliffs. That's particularly true as rising costs are increasingly creating business headwinds for steelmakers.
