Cleveland-Cliffs Inc.
Q4 2020 Earnings Call Transcript

Published: 25 Feb 2021

[Operator:]

Good morning, ladies and gentlemen. My name is May, and I’m your conference facilitator today. I would like to welcome everyone to Cleveland-Cliffs’ Fourth Quarter and Full-Year 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. The company reminds you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in reports on forms 10-K and 10-Q and news releases filed with the SEC, which are available on the company website.

[Lourenco Goncalves:]

Thank you, May, and good morning to everyone on the call. Life at Cleveland-Cliffs has been intense, and we have a number of developments to discuss today. We completed the acquisition of ArcelorMittal USA on December 9, 2020. And a couple of weeks earlier, we completed the construction and begun operating our direct reduction plant in Toledo, Ohio. We have also, one more time, with our financial expertise to good use and took advantage of opportunities presented by the capital markets to improve our balance sheet. And last but not least, we have recently announced our public commitment to aggressively reduce our greenhouse gas emissions 25% by 2030. I will begin with the most transformational theme, the acquisition of ArcelorMittal U.S., including the totality of I/N Tek and I/N Kote, which ArcelorMittal previously shared ownership with Nippon Steel. The very first point I would like to make is the most important part of the acquisition, and that is the people that are now working for Cleveland-Cliffs. I could not be more pleased with the buy-in we have received from the workforce previously working for ArcelorMittal. Not just from the leadership team, but also from the employees at the shop floor. If there is a single reason why we are doing so well as we integrate the new assets to our existing footprint, that is the buy-in from these new Cleveland-Cliffs employees. That came also with the normal support and help coming from the employees that were it does before, included the ones that joining Cliffs from AK Steel. It’s fair to say that the entire workforce, and that includes our union partners, all recognize that Cleveland-Cliffs’ unique business model is now the envy of the steel industry, and they seem to be proud of that. We are too ideas without the strategy are nothing. And the strategy without execution is irrelevant. But one can only execute if the people involved believe and buy in. Our great workforce, integrated and unified under a common strategy and disciplined execution, is the reason why we have been so successful. To our entire team, thank you all very much.

[Keith Koci:]

Thanks, Lourenco. Before I get into the specific results that were foreshadowed with our pre-announcement a month ago, I will first discuss our new business segmentation. You saw in today's release that we are now split into four segments, but the bulk of the operational and commercial activity will take place in our Steelmaking segment. The foundation for this is driven by how the management team views our business. The strategic rationale behind our two major acquisitions was to form one large and competitive, fully integrated steel company, which is exactly what this segment represents. This segment captures effectively all of the production activity that begins at our mine sites, including our pellet plants and other raw materials operations, and ends with our steel and finishing plants. Products sold for this segment includes slabs, hot rolled, cold rolled, coated, galvanized, stainless, electrical, tinplate, plates, rail, forgings, pellets and HBI. Our downstream units will remain as separate segments due to the different commercial nature of these businesses, though they remain an important piece of our integrated entity. Because of this reporting change, we will not have any significant, noticeable intersegment eliminations going forward, other than the small impact from the finished steel sold to our downstream segments resulting in a much smoother and cleaner model. As for our results, our fourth quarter adjusted EBITDA of 286 million represented 127% increase over last quarter and 158% increase over last year's fourth quarter. The sequential increase was driven by the following

[Lourenco Goncalves:]

Thanks, Keith. What a year 2020 was. And what a phenomenal company we have formed during 2020. Rather than panic during the most challenging days of the pandemic, we went on the offensive and took advantage of the amazing opportunities out there to improve not only ourselves, but also to change for good the steel business environment in the United States. As the new Biden administration starts to work towards infrastructure, manufacturing, environmental responsibility and good pay middle class union jobs, we believe we have just built the perfect company to thrive in these challenging times that we are in. We are ready to make our market on the industry with our 25,000 employees all rowing in the same direction, and we can't wait to show you what we can accomplish. With that, I will turn it over to May for Q&A.

[Operator:]

Thank you, sir. We have our first question from Seth Rosenfeld from Exane. Your line is now open.

[Seth Rosenfeld:]

Good morning. Thanks for taking our questions. If I can kick off, please, with a few questions on the integration of ArcelorMittal assets. I'm wondering if you can give us a bit of color, I guess, in terms of what perhaps surprised you most about the asset post acquisition. How comfortable are you with asset quality? Is there any need to invest more CapEx going forward you should flag at this stage? And we understand that a lot of what happened in late 2020 were a number of challenges at their delivery performance. What do you think can be done in order to improve that and really bring that up to policy you have been able to do within AK? Thank you.

[Lourenco Goncalves:]

Good morning Seth. Asset quality of ArcelorMittal is a notch below the asset quality that we found at AK Steel, but that’s way above the average of the industry. I did not see any massive concerted efforts to reduce the reported costs that are calling other companies during the last several years happening at ArcelorMittal USA. This being said, it was clear that some more maintenance CapEx should have been spent, at least, at the very least in the last one or two years, so we are going to have to play a little catch up, but this is all reflected in the numbers that we are anticipating. So nothing to be worried about. Long story short, even though it’s not like AK Steel that we found equipment pretty much in good shape, the equipment at ArcelorMittal is not at the same page, but I cannot call them bad. And the money involved to bring them up to speed, which we have already started spending, by the way, is not anything to be worried above. As far as delivering performance, keep in mind one thing. The same people that are complaining about delivery performance now are the ones that when hot rolled prices were 440, they were not buying because they were waiting for price to go further down. Don't forget that. Now hot rolled prices are above $1,200 and we are doing everything we can to take good care of this client. But there are clients and clients and clients. We are taking care of the ones that deserve first. The ones that don't deserve that much second. And we also serve the other with the amount of availability that we have left. And that is the nature of the beast. We are not going to overcrowd the market just to see these clients walking away from us with absolutely no concern if things change. And things change in this business unless we do as much as we can to keep things the way they are. And that’s exactly what they are doing. Long story short, we are working for

[Seth Rosenfeld:]

Thank you. That is very clear. If I can ask a separate question, I think you touched on this just now. But how do you think about serving your customers from a volume perspective? I think in the past, at the time of the AK acquisition, you were very vocal in saying you weren't going to increase production in the case of just chasing up for high prices. Today, it looks like demand is also very strong before I talked about that shortage. How would you classify different customers? Is an issue that you are prioritizing the contract auto customers over distributors and traders? At what point would those latter customers become more attractive to you?

[Lourenco Goncalves:]

Look, it’s very difficult to compare, Seth, in a company like us, because one year ago, we are just our own. Six months ago, we were basically AK Steel. AK Steel was a 70-plus percent automotive supply. So the rest of the market was not really a matter of concern, because it was marginal. Now we are 40% supply of automotive. So we have 60% for the rest of the market. The good news is that our way of doing business, because we came from a Cleveland-Cliffs and AK Steel background is to supply on time, is to deliver just in time, is to take care of the customers' needs. So we do that naturally.. We had one excellent moment of fixing automotive inventories when we were going through the horrible three months at the beginning of the pandemic when automotive shutdown and we fixed our inventory. We are doing the same right now with the ArcelorMittal assets. And a little bit of help you are getting from the chip manufacturers that are not delivering the chip to automotive. And by the way, it was the same thing, automotive shutdown, the chip manufacturers have to generate return to their investors and they start selling to other people and other industries. And now they are coming back to the automotive. Like I mentioned in my prepared remarks, things will be fixed during the year. But our way of doing business, the systems we have in place, the people that are running commercial, Seth, just to let you know, are basically the people that we are running commercial for AK Steel. So that’s not the full position. Our production planning is geared towards delivering on time. So even though it is far from perfect at this point, it is a lot better than our competition. And in this race, you don't need to be big into the - to the fastest lap all the time, but we absolutely need to do better than the competition. So we know exactly what the competition can do, and we are doing better than the competition, that’s why we are gaining market share. for that. We just need to improve our delivered performance above the competition. That’s what we’re doing. Okay, Seth?

[Seth Rosenfeld:]

Perfect. Thank you.

[Lourenco Goncalves:]

Thanks.

[Operator:]

We have our next question from Lucas Pipes from B. Riley Securities. Your line is now open.

[Lucas Pipes:]

Hey, good morning, everyone, and congratulations on a tremendous year.

[Lourenco Goncalves:]

Thanks, Lucas.

[Lucas Pipes:]

Lourenco and Keith, when I go through the historical results for CLF, AKS and ArcelorMittal USA and I add in synergies, I shake out at EBITDA, call it, in the kind of high $2 billion range for prior market peaks. But then steel pricing during these prior market peaks was much lower than it is today. So I wondered if there is a perspective on your earnings power in the current market environment that you would be able to share. Thank you very much.

[Lourenco Goncalves:]

Okay. Look, we are not going to discuss modeling in investors call, but just to directionally guide you through how things work. Contract prices with automotive, they stay in place for a year. So whatever we negotiated during the pandemic when the automotive clients were not even operating stayed in place. What we negotiated in December when they were back, but still with a lot of scars on the time that they were not in operation, stay in place. So the automotive portion will lag in terms of spot price performance that you see reported in the market every day. That is kind of one side that we can call bad news, not bad news. Otherwise, not every single company out there will be trying to desperately to grow their participation in automotive. It is a net, net positive. But as far as pricing, it lags what you are seeing in the marketplace. But the good news is that with the acquisition of the assets from ArcelorMittal USA, we increased our tonnage in general and we also increased our tonnage to automotive, but we dramatically increased our tonnage to other clients. And to these other clients, even though steel not a real spot transaction, it is a lot closer and a lot faster to materialize the gain. I said in my prepared remarks, we are now down to 40%, mid 38% participation in automotive. So that means that we have a lot more in the market to (Ph) and appliances and (Ph), and stuff like that. So we are selling more in the market, and we are anticipating and accelerating the realization of this higher price. And of course, it is a lot in is good work in a price environment in which hot-rolled is above $1,200 per ton per natural and IODEX is 174 per long ton. It is a lot, lot usage. So we are good. We are good. We are going to have an EBITDA this year that will be higher than the revenues of the previous year when we are Cleveland-Cliffs alone. Very few companies can say that I transformed my yearly revenue and my yearly EBITDA when actually the yearly EBITDA is a little high. So there you can say that, we can. And we will do that.

[Lucas Pipes:]

I appreciate that. And then I wanted to follow-up on the value over volume strategy. Kind of we typically think of integrated steelmakers and integrated suppliers more like base load given the fixed cost nature of the business. So my question is, how should we think about volume more broadly. I think you mentioned six to eight furnaces running typically. Could you translate that into kind of a normalized volume run rate and then, if at all, would you adopt the strategy to, let's say, a new market environment, for example, continue the (Ph) capacity additions or the administration taking another look at Section 232 tariffs? Thank you.

[Lourenco Goncalves:]

Yes. Look, we are not very concerned about what the governments is going to do or not do on the regulatory environment, because President Biden has been very clear that he is not going to give away the farm to trend. That is all one needs to know. So if outsizes are expecting that China level rewrite, they are off to a very bad start because that is not going to happen. The new USDR, that we will expect to be doing well today in our theory is from the trade. She understands, and she is good, as good as or on the same line of port of ambassador . So there is no such a thing as a massive change on the approach to international trade. They need to beef up the details and the Section 232, no Section 232. That is a separate feature. We just can't allow foreigners to control the supply of things that are super relevant to our business. Even the CEO of Ford saying this morning, I read on CNBC, that they can't continue to work with materials, important materials for batteries, if they are going to produce a massive amount of electric vehicle. That is good news because we are the producer of knowing yet at the ESCOs for batteries here in the United States. So everything is shaping up extremely well for our business. Value over volume is also the fact that we acquired ArcelorMittal USA, now we don't need to spend millions and millions of dollars to upgrade our hot-strip in Middletown to produce stuff that I already can at Cleveland or at Indiana Harbor. That is a saving is that we are going to have out of the back we are already enjoying that. So that is value over volume. We are not going to produce more tons just to create a situation that we will have more out there in the marketplace and we will start to see price deteriorating. We will do our part to protect price and that is the right thing to do from the return on capital investment standpoint. We are not going to bring money out of the blue in order to do all the improvements that we need to make in the next 10-years to 20-years to transform the steel business in a real green business. And it is feasible, it is possible, the first step in our company has been taken, because we have the most modern and the only plant in the world that can use hydrogen as of today. So we are ready for that. Just waiting for the hydrogen. That is not our business. So as soon as it is available, over the fence, we will take it because our plant is ready. So we are investing real money. We invest $1 billion in that plant. That is not something that you can do if you are not generating profit. So it is value, it is not volume. It is volume only if the volume comes with value. If it doesn't come with value, we are not trying to sell steel to the ones that were waiting for prices when prices were $440, they are waiting for lower prices to buy. We don't want to deal with these people. We hope that they continue to be waiting.

[Lucas Pipes:]

Good answer. Very much appreciate your perspective. Congratulation again and probably best of luck.

[Lourenco Goncalves:]

Thank you very much. I appreciate Lucas.

[Operator:]

Next is Phil Gibbs from KeyBanc Capital Markets. Your line is now open.

[Philip Gibbs:]

Good morning. So Lourenco and team, you have got a handful here or more than a handful, obviously, contracts in auto and slab, and then you have got a nice big piece of spot business as you pointed out. I mean how should we be thinking about pricing cadence in the Steelmaking segment as we move into the year and just kind of the timing of some of these step-ups. I mean, you have got an integrated model, so this is obviously very leveraged to pricing at this point. And so I think we are just trying to get a feel for, are we looking for a $50 step-up in price. $100 step-up in price, something less than that, because some of these contracts don't kick in yet. So just like a magnitude or just a general direction would be helpful.

[Lourenco Goncalves:]

Yes, directionally, Phil. As far as automotive prices, you make no mistake, we should expect prices to continue to increase and step up every time we renegotiate the contracts, not only because we are putting to these renegotiations, but also because this contract flagged when we negotiated last year, we negotiated in a completely different environment. And now the prevalent market prices around the business are a lot more benign to us and to our negotiation than they were one year ago or even six months ago. That is an undeniable. So these prices will continue to appreciate. Also, we have a meaningful business now selling slabs to AM and in Calvert, Alabama. And that is also a business that will generate good revenue because these automotive quality slabs support their business over there for automotive. So it is another leg up. And you know that is indexed to the international prices for slabs. So that is a good thing and will be a big contribution. Don't forget HBI. HBI is all leveraged to things that are very expensive this day, iron ore with 1. 74 as of mid-morning and crack, that is expenses, and it will become more expensive. So this trend, I'm not going to compete with any numbers, but the trend for price realization is up. So I'm not saying that price will go to $1,200, $1,300, $1,400. That is not what I'm saying. What I'm saying is that with the $1,200 that we are seeing right now, we are going to be catching up with this pricing level. And demand is good. That is the most important thing, demand is fantastic. The clients are complaining that are not receiving steel, remember, these folks campus and they don't want to carry inventory. That is weird. That is strange. I ran a service center company for 10-years. Guess what, service centers carry inventory. That is their goal. That is their business proposition. If a service center doesn't want to carry inventory, he or she is in the wrong line of business. That is something else to do. Open a concept of game stop because that will really provide a lot of wealth to that person if he or she is in the business carrying inventory. So they complain, but they can do the part. So we are fine with what we have. Prices are going up. We are going to depend on that very fast. We have a goal to finish this year with leverage in terms of debt divided by EBITDA, 2.5 times or less, and we will accomplish that.

[Philip Gibbs:]

Thanks, Lourenco, appreciate that. And just a question for Keith on the share count. Obviously, a lot of moving pieces. How do you account for the preferred shares, so just trying to pinpoint what a share count is going to be for Q1 and then also Q2 because I know you had the timing of the offering?

[Keith Koci:]

Yes, Phil. So we ended the year with 477 million common shares outstanding. We issued 20 here in February. So that 20 will get averaged out in the first quarter on a pro rated basis. But for the full-year, you can almost count the entire 20 to be in the numbers. Your potential dilution would be - the preferred is being carried as mezzanine equity, so it will be - you can pretty much count the preferred equivalent of 58 million common that will impact earnings per share. And that would pretty much carry throughout the year. And then depending on where share prices land like, for example, using today's share price, the converts would have roughly around a 20 million share dilutive impact as well. If you want to calculate dilution on the converts. That should pretty much get you there. Does that help?

[Philip Gibbs:]

Which is clean ex-converts, it sounds like it is around 5 70. That is a decent number?

[Keith Koci:]

Right. That is correct. Yes.

[Philip Gibbs:]

And then last one for Lourenco and I will jump off. The HBI project, to your point, very timely. And you mentioned you will be shipping to some third-party customers in the March here. Some of that, I would imagine, is trialing just because you are getting up to speed here pretty quickly. But where do you think you are going to be this year in terms of your mix in the back half in terms of external shipments versus internally consumed shipments? Thanks very much.

[Lourenco Goncalves:]

Phil, we are using our HBI in-house because from the cost standpoint and productivity standpoint, it makes a lot of sense. For example, we are using a lot of HBI in our , twofold. Using HBI saves us on coke so generates less CO2. It is environmentally positive, especially in an area that has been historically very ready to complain, even though they have nothing to complain at this point even without HBI. But we prioritize because it is probably our most delicate area in terms of environmental concerns. So we are doing that. And the second thing is that because saves a lot of money by doing that. So we are happy with that. So that is one location that is very used. We are also using our own EAF, because scrap has been extremely expensive in the marketplace. And as you know, we have a lot of EAF. So we are delivering HBI to our lower EAF in Pennsylvania, and it has been a very net positive cost-wise because we are doing that. All this being said, we are not going to ignore the potential clients and now competitors that helped us get to where we got. I always keep saying that we would not be here if we were not able to produce the grade pellets. And we only developed the ability to produce the grade pellets in Northshore because on day Nucor opened their doors for us to develop the pellets with them in Trinidad. And I will be forever thankful to Nucor for that. And of course, Nucor will be the first one receiving HBI from us in March. And followed by Steel Dynamics, not far from that. And North Star BlueScope will be next. You asked for numbers. It is very difficult to could give a precise number at this point because the nature of this business is transactional. It is a month-to-month negotiation. And by design, it is not that we don't want to have long-term contracts, so we want to have term contracts. That is not how the market works. So we play with the market, we don't change the market. And we are happy with that because that allowed us to use in-house and with a big advantage. But the numbers that we are working with internally is that we are going to be selling half to the outside world and using half in-house. That is a pretty good guidance for you to use.

[Philip Gibbs:]

Thank you.

[Lourenco Goncalves:]

Thank you.

[Operator:]

We have our final question from Alex Hacking from Citi. Your line is now open.

[Alexander Hacking:]

Good morning Lourenco and Keith, thanks for the time. just wanted to start on capital allocation, if I may. I think, Lourenco, you just mentioned maybe you could get to 2.5 times net debt by the end of the year. At what level do you become comfortable with net debt enough to start having a discussion around either ramping up capital returns or making more strategic investments? Thanks.

[Lourenco Goncalves:]

Thank you. Alex, look, first of all, I'm comfortable today, because it is all planned and it is all being taken care of. With the latest transaction, the latest transaction that we just announced, we again recovered our four-year window with no significant maturities, and that is how we have managed the company forever. So the 2.5 times or less at the end of the year is the goal, it is feasible and will be achieved. This year is the year that the entire cash generated by the company, except for the very good and conservative assumptions on CapEx that are not to start any they are actually bringing, like I explained during the call, bringing some equipment back to a better place. But even with that, we feel like we have enough to massively pay down debt. We should pay more than $1 billion in debt this year, just with the cash generation. We don't have any acquisitions in our horizon either at this point. And even that to count people down that we are not going to be continuing to expand. We feel like this year should be spent on integrating, perfecting, improving delivery performance from the AM USA assets, bringing these assets to the same level, deliver performance that we already have from the former AK Steel assets. All these things are on the making and give us very - a piece of pie and make us very comfortable with how things will be taken care of this year. So that is pretty much it. As far as returning capital to shareholders, look, I’m convinced that people that invest on Cleveland-Cliffs, they are not investing for business. They are investing for and if they are, they are investing in their own company at this point, because with all the growth that we demonstrated last year, with all the potential that we have right now in terms of continuing to generate real equity by paying debt and moving the numbers from the debt side to the equity side for the same enterprise value, that is what I should be doing. And that is exactly what I'm going to be doing. So one year ago when we were talking in this call, I was talking about iron ore. This year, I'm talking about being the leader in flat rolled steel in North America and making sure that the market behaves and these prices that we are seeing right now are in good shape, on behalf of our shareholders to generate return on invested capital. One year from now, we will be talking about the company with very little debt, and then we will talk again. I hope I got it your the point of your question. If not, please, by all means, let me know.

[Alexander Hacking:]

Thank you. That was great. And then let me just follow-up on one other question, if I may. So firstly, congratulations on the sustainability goals that you put in place. Do you envisage significant CapEx investments associated with reducing the carbon footprint? Or is it more a series of smaller incremental investments that will enable you to towards?

[Lourenco Goncalves:]

I'm sorry meaningful CapEx, I will kind of is we want to set after that. Can you repeat?

[Alexander Hacking:]

Sorry, meaningful CapEx associated with fitting your emissions targets, your 2030 targets.

[Lourenco Goncalves:]

No, the meaningful CapEx that I have to deploy, we already did, was to put our direct reduction plant in place. That is done. So we are talking $1 billion in (Ph) almost $100 million in upgrades in our Northshore mining operation in Silver Bay, Minnesota. So we have already invested that massive amount. Everything else will come in incremental events, and they do not demand a lot of CapEx. Also, some of these investments are done and will continue to be done by our partners, like the investment made by to replace power supply from traditional source of fuel to a brand-new state, actually two brand-new state of the art plants using natural gas. So we are there. We are moving there. We are going to continue to introduce HBI in our blast furnaces. And that will continue to reduce our consumption of coal and coke. So all these things have an environmental impact. And actually, they are positive for cost. I tend to agree when I hear President Biden talking that environmental compliance can be done and can be done, generating good paying union jobs, I checked mark that, and reducing costs, I checked mark on that as well. The investments, the massive amounts of CapEx in all cases are not that relevant or at the very least they have already been done.

[Alexander Hacking:]

Great. Thanks Lourenco. And congrats on the transformation of the company last year.

[Lourenco Goncalves:]

Good, I appreciate. Thanks a lot.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect. Have a great day.