Cleveland-Cliffs Inc. (NYSE:CLF) Q3 2023 Earnings Call Transcript

Cleveland-Cliffs Inc. (NYSE:CLF) Q3 2023 Earnings Call Transcript October 24, 2023

Operator: Good morning, ladies and gentlemen. My name is Daryl, and I am your conference facilitator today. I would like to welcome everyone to Cleveland-Cliffs’ Third Quarter 2023 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’s website. Today’s conference call is also available and being broadcast at clevelandcliffs.com. At the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss results excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published this morning. At this time, I would like to introduce Lourenco Goncalves, Chairman, President, and Chief Executive Officer.

Lourenco Goncalves: Thank you, Daryl and thanks to everyone for joining us this morning. Before Celso starts the discussion of our Q3 results, I want to provide another brief disclaimer. Back in August, we announced a potential exciting and transformational opportunity for Cleveland-Cliffs. Since then, restrictions have been put in place on what we can say or disclose, and therefore, for the time being, we cannot discuss the issue. So before you start wondering why you’ll not hear anything about it, that’s why. With that out of the way, I’ll turn the call over to Celso.

Celso Goncalves: Hi. Good morning, everyone. In Q3, we generated revenues of $5.6 billion, adjusted EBITDA of $614 million, and GAAP earnings per share of $0.52. Total shipments reached 4.1 million net tons, and despite the UAW strike impacting three of our clients in the automotive sector. Aggregate shipments to all of our automotive clients collectively were higher in Q3 than in Q2. Steel shipments from Cleveland-Cliffs to the automotive sector in Q3 were actually a quarterly record. During the quarter, we generated free cash flow of $605 million. As planned, we used the majority of that cash to paydown our ABL, bringing our net debt down to $3.4 billion and boosting our total liquidity up to an all-time high of $4.4 billion.

We also returned approximately $60 million to shareholders by buying back 3.9 million shares during the quarter. With our ABL balance down to only $325 million, we now have a capital structure comprised primarily of low-cost fixed coupon debt instruments with no upcoming maturities until 2026. Since acquiring ArcelorMittal USA in December, 2020, we have reduced our net debt by nearly $2 billion and eliminated another $3.5 billion in pension OPEB liabilities. That’s a 60% combined reduction in net debt and post-retirement liabilities in less than three years. Over the last couple of years, we have also reduced our diluted share count by 13% from a high of 585 million shares to only 509 million shares today. Elaborating further on our Q3 results, shipments remain resilient despite slowed service center sales during the quarter.

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Q&A Session

The maintenance activities we performed last year have paid off for us as our operations have been running reliably, affording us the ability to achieve these strong shipment levels all year. As I said before, notwithstanding the UAW strike, steel shipments to automotive clients actually increased sequentially in Q3. This outperformance in automotive steel shipments and the lower service center shipments helped to mitigate the change in average selling prices quarter-over-quarter with a richer mix, holding strong above $1,200 per net ton even after the drop in overall index prices during the quarter. Our cost reduction performance was also very good during Q3, improving by $31 per net ton quarter-over-quarter. This came in less than our previous guide, only due to this mix factor, but we were happily take that trade off due to much higher prices associated with better mix.

We expect cost to fall by another $15 per net ton during the fourth quarter. Since Q3 of last year, we have reduced unit costs by a total of $165 per net ton year-over-year. That is roughly $2.7 billion in savings at an annual run rate. This solid performance in costs is expected to continue into next year. We are happy to report that our annual metallurgical coal buy will result in a $250 million reduction in 2024 coal costs. We executed these 2024 annual contracts during Q3 and our negotiations were very well timed as global met coal prices rallied shortly thereafter. Among other savings, we have also locked in an additional $150 million in savings for fixed natural gas costs in 2024. With that, I’ll turn it back to Lorenzo.

Lourenco Goncalves: Thank you, Celso. As you may recall, we had to sacrifice production and shipments last year to bring some of these steel mills acquired in December, 2020 from ArcelorMittal USA to a reliable level of performance. Automotive is our biggest market, and we were anticipating much higher demand for automotive steel coming into 2023 versus 2022. Fast forward to Q3, our demand forecast has been confirmed and we have absolutely taken advantage of that. Q3 was our third straight quarter with total steel shipments above 4 million net tons, even in a business environment where service centers sat on their hands and were not actively buying for most of the quarter. The automotive business in the United States is extremely competitive.

Automotive is an industry that steel two producer wants to serve. When we negotiate our annual deals, we are competing against offers from countless other suppliers, including Korea, Japanese, German, other European, as well as against Mexican joint ventures and Mexican trans shipments. We also have seen growing competition from EAFs and the ongoing threats from aluminum substitution. There is no unfair advantage we have from that standpoint. The United States is by far the largest importer of steel in the world, importing more than 30 million net tons of steel in 2022 alone. No matter what change with the market structure of integrated blast furnace based oxygen furnace operations in the United States might happen, these competitive forces are there and will continue to be there.

What sets Cliffs apart in automotive is our excellence at serving the clients. We are just better at meeting our customer’s needs in a detailed, driven and customized business like automotive, reliable quality, customer service, and meeting just in time needs are paramount and Cliffs does that better than anyone else. We have been willing to sacrifice throughput to serve the wide variety of parts each one of the clients need. We have to reserve our valuable capacity to align with their production forecast, and we hold inventory for our automotive clients. As I have said before, our steel buyer for a giving car manufacturer can replace Cliffs with another steel supplier just to buy cheaper steel from them for a little while, but history tells that they will come back to Cliffs after the buyer or the decision maker above him or her, or both the buyer and the boss are replaced with someone else.

We have seen that happen time and time again. Cliffs position in automotive has been earned, not given, and we continue to fight. There’s numerous competitive forces every day to maintain and improve this reputation based on excellence. As a direct result of increased automotive production volumes, we actually set a new company record for direct automotive shipments during the third quarter, surpassing the previous two healthy quarters, even in the midst of model year changeovers and all the uncertainty before the strike was called by the UAW. So far, the strike affecting a number of plants of the Detroit Three has not impacted us materially on a direct automotive basis. As of right now, the impact of the current outages on Cliffs are less significant than what we felt from the microchip shortage and other supply chain issues the entire automotive sector went through in 2021 and 2022.

Also important to say, the majority of our automotive shipments do not go to the Detroit Three, and that’s particularly true for our largest customer, which is not one of the Detroit Three. In fact, we have seen much better demand from these other automakers. As a result, we expect total shipments in Q4 to remain around the 4 million net ton mark, even if the UAW strike continues for a while. Conversely, the service center sector was the one creating in Q3 the most negative impact associated with the UAW strike, not the automotive OEMs themselves. As expectation of a strike kept picking up steam in July, service centers did what they always do when they face uncertainty. They destocked and sat on the sidelines. However, the strike has not had nearly the impact these folks anticipated, and they got caught flat footed again.

The best evidence of that is how quickly our two recent price increase announcements gained traction in the marketplace. As for our annual automotive negotiations, our October 1st renewals, which represent about 30% of our total annualized auto volumes were another success. We held onto important volumes and did not take any price decreases. In fact, in these negotiations, we’re successful in implementing the Cliffs H surcharge that we discussed last quarter. As a reminder, Cliffs H represents the premium we charge for supplying our customers in the United States with steel produced with close to 30% scrap in our base oxygen furnaces and using HBI in our blast furnaces. Our clients in automotive and other sectors as well cannot that — get that in Europe or in Japan or in Korea or in India or in China.

As a consequence of our operating practices utilizing HBI and maximizing scrap, Cliffs is among the lowest carbon intensity blast furnace base oxygen furnace operations in the entire world, and certainly much better than any of the current top 10 largest steel producers in the world. While Cliffs H is a very important first step in decarbonizing the production of sophisticated grades of steel, earlier this month we saw the most consequential step forward in advancing to the Cliffs H two phase in which we will implement the use of hydrogen as reductant in our blast furnaces. On October 13th, as part of the Bipartisan Infrastructure Law, the White House and the US Department of Energy announced the plan to commit $7 billion toward clean hydrogen hubs across the country, including among the chosen locations northwest Indiana, the most critical region for Cleveland-Cliffs.

As you have heard me say in the past, it’s not where — about where the bow is right now, it’s all about where the bow is going to be and where the bow is going to be is hydrogen. Hydrogen is the future. Effectively, all of the current carbon emissions in our footprint are a result of the use of fossil fuel based reductants or energy sources, where there is no economically feasible alternative. Hydrogen can and ultimately will change that. Cliffs’ commitment to buy a large portion of the output from the Midwest hub helped get this location selected by the Department of Energy. Furthermore, our commitment of a significant offtake ultimately makes the hub viable as we solved the chicken and egg dilemma. The very existence of the hub should attract other sectors and other uses, including the viability of production of hydrogen fueled vehicles as a clean and viable alternative to battery powered EVs. Most steel companies have decided that spending billions of dollars in building new EAF based capacity to recycle scrap with growing residual copper content is the way to go.

Unlike taking that path, we at Cleveland-Cliffs prefer the higher steel quality that comes with blast furnace based oxygen furnace steel making. In addition, if hydrogen is available and cost competitive, and you already have blast furnaces, the use of hydrogen is very minimally capital intensive. Only minor additions are needed, like the new pipeline we are currently installing at our Indiana Harbor plant. Our decision to use hydrogen as our decarbonization path set us apart from the crowd and that will be accomplished in a much more cost effective and quality driven manner. On that note, I want to emphasize one more important point. We appreciate the value that the Biden administration places on projects and investments that sustain and grow good-paying middle class union jobs.

Regulatory authorities have been strict on fighting M&A deals that harm workers, and rightfully so. Most of you have followed Cleveland-Cliffs for years and are very familiar with the way in which Cleveland-Cliffs works collaboratively with our union partners, in particular, the USW, the UAW, and the International Association of Machinists. I’m grateful that President Biden’s administration is aligned with us in our long-term collaborative approach with the unions and has taken notes that Cliffs puts workers at the center of our strategic decisions and growth objectives. Last but not least, one person who would have been excited about these great opportunities is the late international president of the USW my dear friend Tom Conway. We shared the same views on a vibrant middle class in the resilient American manufacturing sector.