Cleveland Cliffs is an interesting situation. Wall Street analysts universally hate the company. The reason why is one of those two-handed situations.
On the one hand, steel companies have had a hard time in the US as government subsidies by the Japanese, Korean and Chinese governments made it difficult for their US counterparts to compete. On the other hand, the bulls think the company is competitive so that it will shine in the years ahead.
Cleveland-Cliffs Inc. is a flat-rolled steel producer in North America. The company offers carbon steel products, such as hot-rolled, cold-rolled, electro-galvanized, hot-dip galvanized, hot-dip galvannealed, aluminized, enameling, and advanced high-strength steel products; stainless steel products; plates; and grain-oriented and non-oriented electrical steel products. The products go into automobiles and other industrial products.
It also provides tubular components, including carbon steel, stainless steel, and electric resistance welded tubing. In addition, the company offers tinplate products, such as electrolytic tin coated and chrome coated sheets and tin mill products; tooling and sampling; raw materials; ingots, rolled blooms, and cast blooms; and hot-briquetted iron products.
The company is vertically integrated. It owns five iron ore mines in Minnesota and Michigan. Cleveland-Cliffs Inc. was formerly known as Cliffs Natural Resources Inc. and changed its name to Cleveland-Cliffs Inc. in August 2017. The company has been around a while. It was founded in 1847.
The price action of the company’s stock is bullish but not wildly so. It is in a very long-term slow bullish trend channel that we think will continue for decades. Short term, this stock hit bottom in 2016 and again at C19, and we think the trendline connecting these lows is super strong support. For this reason, we are bullish on the stock on a technical basis.
Valuation is even more compelling. The company is making money hand over fist. So long as the car industry holds up, we think the company will continue to print money. In 2021, the company made $5.36 per diluted share of stock. Analysts expect the company to make $5.33 a share in 2023, but then they expect earnings to fall off a cliff to $3.17 a share. This implies a PE ratio of just 3.1 based on forward-looking earnings. We do not know of an established company whose stock is trading at such a depressed level. We do not share analysts’ pessimism about future earnings. The company is competitive, and we see the car industry providing steady demand for years. If and when the street changes its tune, we think the stock will trade much higher. Until then, we see a minimal downside in the company’s shares.
Given this thesis, we think long-only stock investors should buy the stock outright. For options traders, we think they should consider selling cash-covered puts. With CLF trading at $16.56, considering the following structure.
In this trade, the investor will collect $117 upfront, which they get to keep. This might not seem like a lot, but this is a low-priced stock, so the yield is quite high. Since this structure is a cash-covered put, one will need an additional $1,483 in cash to back up the trade. The investors will have to put this money to work if the share price trades at $16.oo or less at expiration. The breakeven level is 10% below the current price. This provides plenty of room for error. The implied volatility is about 58%, as investors fear the company may suffer in a recession. Given this level of volatility, there is only a 35% chance of making money on the trade. We like those kinds of odds on a company that is making a lot of money. Time will tell if we are right.
Remember to trade small and diversify your exposure. Do not let any trade become so big it keeps you up at night. We are at a very precarious stage of the bear market. We expect most stocks to fall. But there will be a few that will buck the trend and we think CLF will be one of those.
Photo by Anamul Rezwan: https://www.pexels.com/photo/cut-off-saw-cutting-metal-with-sparks-1145434/
