Cleveland-Cliffs (CLF -11.03%) changed its stripes in 2020 with the acquisition of AK Steel, a former customer. The move was a huge overhaul, taking Cleveland-Cliffs from the role of steel industry supplier to integrated steel mill. Only it came at a big cost in the form of skyrocketing leverage. Management is using the steel industry upturn to do something about that.
A timeline of debt
Between the start of 2020 and the first quarter of 2021, Cleveland-Cliffs' long-term debt grew by a huge 240%. There were two big jumps over that span, one in early 2020 and another in late 2020 that carried over into early 2021. Those moves coincided with Cleveland-Cliffs' acquisitions of AK Steel and the U.S. business of global steel giant ArcelorMittal.
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This was not a minor change. The company completely reinvented itself in a roughly two-year span. Today, Cleveland-Cliffs is an integrated North American steel giant with a heavy blast furnace footprint. Blast furnaces aren't as flexible as newer electric arc mini-mills, but when they run at high utilization levels they can be hugely profitable. And with Cleveland-Cliffs controlling some of its key input costs, to some degree, it has an added cost advantage in the industry.
But, to make this transition, the company's leverage levels ended up way out of line with peers'. For example, in 2020 Cleveland-Cliffs' debt-to-equity ratio was at a huge six times compared to less than 1.5 times for United States Steel (X -2.32%) and less than 0.8 times for both Nucor (NUE -8.87%) and Steel Dynamics (STLD -2.29%). In some ways, Cleveland-Cliffs' acquisitions, notably of AK Steel, looked like it was trying to save key customers that were dealing with heavily leveraged balance sheets at a point when the steel industry was weak.
From that peak, Cleveland-Cliffs' debt-to-equity ratio has headed steadily lower, thanks at least partly to solid earnings. Today, its debt-to-equity ratio is a touch under 0.7 times, still higher than that of steel industry peers but much closer to the roughly 0.4 times or so that US Steel, Nucor, and Steel Dynamics are at.
Putting money to good work
In addition to strong recent results, Cleveland-Cliffs has also been actively looking to strengthen its balance sheet via debt reduction, in essence putting cash flowing out of the current market upturn to work. Notably, the company's long-term debt levels have declined around 18.5% since early 2021. Management is clearly putting a focus on debt reduction after leveraging up so it could quickly change its business model.
There is, however, a cost to this effort. For example, in the second quarter debt reduction costs amounted to $0.13 per share. That was the biggest one-time item during the quarter, which saw $0.18 in such one-time costs. If the debt reduction hadn't taken place, earnings would have been around 10% higher. That's a pretty significant difference. Given the still elevated debt-to-equity ratio compared to peers', the company's debt reduction efforts probably aren't over yet, either.
In fact, even after the debt reductions that have been made so far, the company's long-term debt still stands at around 120% higher than it was before its steel acquisitions. Clearly, it can handle a larger debt load now that it has a larger business, but with a debt-to-equity ratio of 0.7 when peers are closer to 0.4, management can't stop yet. Luckily, the cyclical steel industry has been benefiting from strong demand and pricing recently, so Cleveland-Cliffs has been able to act quickly on the balance sheet front. That tailwind will likely continue for at least a little longer, but striking while the iron is hot shows notable management resolve.
Turning skeptics into believers
When Cleveland-Cliffs first started down the path of being an integrated steel mill, the level of debt it was taking on was frightening given the financially weak state of AK Steel at the time. However, Cleveland-Cliffs appears to have timed this move well and, now that it is reducing debt, it is getting itself back in line with peers on key financial metrics. There's more work to be done, but so far management looks like it has pulled off this transition with great success.
