Cleveland Cliffs : Transcript Q1 2024

Cleveland-Cliffs, Inc.

First-Quarter 2024 Earnings Conference Call

April 23, 2024

Presenters

Lourenco Goncalves, Chairman, President & Chief Executive Officer

Celso Goncalves, Executive Vice President & Chief Financial Officer

Q&A Participants

Lucas Pipes - B. Riley Securities

Bill Peterson - JPMorgan

Phil Gibbs - KeyBanc Capital Markets

Alex Hacking - Citi

Tristan Gresser - BNP Parabas

Lawson Winder - Bank of America

Operator

Good morning, ladies and gentlemen. My name is Rob, and I am your conference facilitator, today. I would like to welcome everyone to Cleveland-Cliffs First Quarter 2024 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 release 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 yesterday.

At this time, I would like to introduce Celso Goncalves, Executive Vice President and Chief Financial Officer.

Celso Goncalves

Good morning, everyone. As I did on the last conference call, I'm going to start, today, by providing an update on capital allocation and M&A.

On our last call in February, I indicated that we would be much more aggressive with returning capital to shareholders and made it very clear that share buybacks are now the number one capital allocation priority for Cleveland-Cliffs.

Consistent with what we said we would do, we bought back more than 30 million CLF shares during Q1 by utilizing the remaining $608 million from our prior $1 billion share buyback program, announced in 2022.

In the last couple of years, we have reduced our diluted share count by over 100 million shares, or 17%, realizing an average purchase price of $18.79 per share on open market repurchases, significantly below where we are trading, today.

Going forward, given our strong free cash flow outlook and healthy liquidity, we are introducing a new $1.5 billion share repurchase program that we plan to deploy immediately and aggressively during open windows.

This new buyback program is also supported by the fact that we are no longer compelled to preserve as much dry powder for M&A, given the limited number of possible outcomes for U.S. Steel.

It's now clear that their "strategic alternatives review process" was only "robust" and "competitive" because the company and their financial advisers at Barclays and Goldman Sachs invited foreign buyers, creative consortiums and companies with no support from the USW.

As we explained to U.S. Steel, to their advisers, and to the entire market early in the process last year, there is no way to close the sale of U.S. Steel without agreement and full support from the USW. We discussed publicly in August that the USW has de-facto veto power in the outcome of this process, but U.S. Steel denied it. Back then, Cliffs was right and U.S. Steel was wrong. Today, we continue to be right and they continue to be wrong.

There's no denying reality anymore. The USW has said from the very beginning that they would not endorse any other buyer, only Cleveland-Cliffs. Union leaders do not go back on their word. And now after President Biden has clearly expressed his position, unequivocally, against foreign ownership of U.S. Steel, the list of real buyers for the company is even more evidently a party of one. Cliffs is the only union friendly American solution for U.S. Steel. The Nippon deal is dead and other buyers stand no chance to close a deal involving U.S. Steel union assets.

In terms of value, the inflated bids resulting from the blind auction process that included unrealistic buyers don't represent a meaningful proxy for real valuation and neither do the

standalone price targets coming from research firms pandering to the arbs. A company is only worth what a real buyer or investor is willing to pay for it, and everything else is just an opinion.

The last time that real steel industry investors owned U.S. Steel, the stock was valued at $22.72. The valuation reset lower is far from over. We will have to reassess everything, including value, once we have the chance to reengage in M&A due diligence, as everything we saw last year is now stale.

Obviously, there is no assurance that U.S. Steel will even want to sell to Cliffs. The company can always stick around as a standalone entity and the arbs holding the stock can always sell their shares back to the real investors in the $20's. In the meantime, Cliffs will continue to buy back our own CLF stock, hand over fist like we did in Q1.

Buying our own stock and returning dollars to our Cliffs shareholders, who are real investors, is a much better use of capital than any M&A opportunities at current valuations.

From a leverage standpoint, we are implementing a more shareholder-friendly leverage target of 2.5 times net debt to last 12 months Adjusted EBITDA, allowing ourselves even more flexibility for aggressive shareholder returns.

We have made a lot of progress on the balance sheet over the past few years. As of the end of 2023, we outperformed our prior net debt target level of $3 billion, but the rating agencies gave us no credit for the massive debt reduction last year and kept our ratings unchanged. If the agencies are just going to keep our ratings where they are now, we might as well give ourselves the flexibility to buy back more stock.

At 2.5 times net debt to EBITDA, there is also no risk of a ratings downgrade from where we currently are. We have flexibility up to 3 or 3.5 times, before risking any downgrade. By self- imposing the 2.5 times threshold on ourselves, we are just allowing for more flexibility, while remaining comfortably within the spectrum of our existing ratings category.

This new leverage target just gives us the ability to continue to execute open market share buybacks. And even if we deploy the entire $1.5 billion program throughout this year, our net leverage would still be comfortably well below 2.5 times.

This new leverage target also applies in the context of M&A. Any acquisition situation would also be limited to pro forma net leverage at the same self-imposed 2.5 times target level.

Obviously, any M&A that we do will come with meaningful EBITDA contribution, significant synergy realization and increased scale that will be viewed by the rating agencies and bond investors as a credit positive.

For the avoidance of doubt, we are not currently performing due diligence on any M&A opportunity that would prohibit us from buying back stock today. And even if the U.S. Steel situation were to resurface at some point in the future, we would need to refresh our due diligence at that point and reset valuation expectations from current levels.

Our balance sheet continues to be in great shape with near record liquidity and no secured bonds in our capital structure for the first time since 2017.

During the quarter, we launched the redemption of our final tranche of secured debt that was also our nearest dated bond maturity. With no debt maturities until 2027, we now have a 3- year maturity runway that gives us even further comfort with our new target level. This is the best shape our capital structure has been in since Lourenco took over the company ten years ago.

As a result of higher automotive sales during the quarter, our Q1 adjusted EBITDA of $414 million marked a rebound in profitability from the latest trough in Q4. With production and sales of cars, trucks and SUVs remaining healthy in the U.S. throughout Q1, our average sales pricing came in much better than expected, due to a greater participation of automotive in our Q1 steel sales mix. Conversely, in January and February, service centers went on a typical buyers' strike, which led to reduced sales to the distribution sector.

The net result of this dynamic of more sales to automotive and fewer tons delivered to service centers led to a reduced sales output of 3.9 million net tons. Now that the distributors and service centers have come off the sidelines and steel pricing is on an upward trend, we expect to again exceed the 4 million ton shipment level in the second quarter.

Unit costs were, of course, impacted by the heavy automotive mix in Q1, as well as the overall lower production volumes, though we maintain our previous guidance of an approximately $30 per net ton reduction in unit cost in 2024, compared to 2023. That will begin here in Q2 with an expected $20 per ton drop in costs, quarter-over-quarter.

The lower production volume in Q1 and heavier automotive mix impact on unit cost, have been offset by lower natural gas prices. As is typical in the first quarter, working capital represented a use of cash, which we expect to recover in the second quarter.

Also during Q1, as widely publicized by the U.S. government, we were selected for award negotiations related to two decarbonization projects for a total of $575 million worth of DOE grants. These projects should not impact our capital spend expectations for this year. And in the case of the Middletown DRI EMF project, the new investment will, significantly, mitigate future expenditures related to the Middletown blast furnace and other infrastructure.

Our investment expectation related to the two projects is that our net capital expenditures will hover around $1 billion from 2025 through 2028 with the ultimate outcome of $550 million in annual cost savings starting in 2029, with virtually no impact to production.

With that, I will turn it over to Lourenco for his remarks.

Lourenco Goncalves

Thank you, Celso, and good morning, everyone. Cleveland-Cliffs has a very simple, yet somehow unique way of conducting business in corporate America. We respect our workforce.

There is nothing special or particularly complex beyond that. Our employees drive our performance and our profitability. Our workforce is the reason why we're here, and they are treated accordingly. Of course, this has always been the case during the last 10 years I have been running Cliffs. But the events of the past year have, obviously, shed a brighter light on this.

Our relationship with all workers and, particularly, with the union represented workers, is a function of the long view we have taken with respect to our labor force and not something that can be outshined by empty promises from outsiders written on worthless pieces of paper.

Nippon Steel, the unsuccessful attempted acquirer of U.S. Steel, has failed to understand this. It still baffles me to this day that the clueless individuals representing Nippon Steel in this embarrassing event felt that they could do this, without union support. You just cannot do it with a USW represented workforce.

This historic M&A fiasco was a direct consequence of the goals the U.S. Steel CEO and his fellow Board members had in mind. First, to do good for the stockholders only, ignoring everyone else; and second, to break the back of the USW. Therefore, for them, it was necessary not to sell to Cleveland-Cliffs.

To give a sense of the enormous prejudice against Cliffs and against the USW, despite all we have clearly demonstrated to them, the U.S. Steel directors and their advisers from Milbank, Wachtel, Goldman Sachs and Barclays, still chose a buyer that cannot close the deal.

We are grateful that the U.S. government shares the same view we have always had about the importance of union jobs for a thriving middle class in America. The Biden Administration has different ways to terminate the Nippon transaction, and we believe that will be done sooner rather than later.

Before the President of the United States had expressed his clear position, we attempted to offer a solution to Nippon Steel, where we would acquire the union represented assets of U.S. Steel, and Nippon would keep the assets they wanted in the first place, the non-union Big River steel facility.

Nippon did not accept that. And now after President Biden has spoken, this option is no longer available to them. Nippon is now saying they actually value the blast furnaces because they can apply their great technology.

Let me be clear; this talking point on technology is complete hogwash. There is nothing special about the Japanese blast furnace technology. We are far ahead of them on everything blast furnace related. The use of iron ore pellets and no sinter, direct reduction, the charging of HBI in blast furnaces, the injection of natural gas and hydrogen, we already have all that in the United States at Cleveland-Cliffs, and they do not have any of that in Japan.

Their so-called superior technology is not even remotely based on facts. But one thing that's good about Nippon Steel now being hell-bent on owning blast furnaces and BOFs in the United States is that people that used to say that blast furnaces and BOFs are bad don't know what to say, anymore. They are now on mute.

Thanks, Nippon Steel, for validating my point. You have to pay the breakup fee of $565 million just to prove my point, and I appreciate that. Your money will be well spent.

Another relevant point ignored by the U.S. Steel board, Nippon still has been a perpetual violator of our trade laws, probably the worst actor in the international steel trade over the past several decades among all. In my view, Nippon Steel is actually worse than the Chinese. And they also have significant interest in China, which they love to downplay. Unfortunately, for them, Nippon Steel cannot hide their deep ties with the Chinese, and that has also been completely exposed.

Nippon's existence in the U.S. is also bad for customers. By the way, in order to obtain a price increase back in Japan, Nippon Steel has recently sued the largest Japanese automotive manufacturer, Toyota. Cleveland-Cliffs has never done that here in the United States and for the record, Toyota here in the United States is our largest automotive client.

When this thing ultimately ends, we are in a whole new world. If the feelings of U.S. Steel directors are hurt, but by what I have said or done and they still don't want to sell the company to Cleveland-Cliffs, that's their prerogative. At the end of the day, they don't have to sell themselves to Cliffs, and there is no easy way to force them to do so. But their only other alternative after they collect the breakup fee from Nippon is to continue as a standalone company. If that's going to be the case, good luck running the assets that you hate with the workers you don't respect.

From our side, Cliffs has several other opportunities, with or without M&A. The most relevant example of that, right now, is our share repurchases. We were overdue in Q1 and with our new reauthorization we are still buyers of our stock at today's price. We also just displayed our

ability to grow profits organically, with the two projects we are initiating with support of the U.S. government.

The $1.3 billion investment at Middletown Works replacing our blast furnaces with a DRI facility and two electrical melting furnaces is a game changer for our company and for our industry. The $500 million co-investment we will receive makes this project the largest federally supported de-carbonization initiative in U.S. history.

The government took note of our investment in direct reduction made seven years ago, as well as our 30% reduction in CO2 emissions over a six-year period and our technological advances on hydrogen utilization.

In our recently published Sustainability Report, we reported another reduction in integrated emissions intensity to 1.54 metric tons of CO2 per metric ton of steel, down from 1.82 in 2020 and, significantly, below the current global average of 2.15. When the Middletown project is in full operation, Middletown Works will be the lowest cost steel producing facility in the United States.

To illustrate the cost savings, our current cost to produce pig iron in Middletown is about $470 per net ton, and our current cost to produce DRI is less than $200 per net ton.

Hot DRI will be fed into a melting furnace, a very simple process to melt solid DRI into liquid, creating a pig iron equivalent that can be fed into our existing BOFs and process it further, downstream.

Knowing that scrap will become scarce, expensive and more contaminated over time, we will avoid any increase in our scrap intake, maintaining our ability to serve the highest quality demand in end markets, like the automotive, market by using pure iron. That's technology, American technology, not Japanese hogwash PR.

At Butler Works, we were awarded $75 million by the DOE to replace our natural gas fired slab reheat furnaces with electrified slab furnaces. That will reduce emissions, improve productivity and enhance our production of GOES, grain-oriented electrical steel, critical to our country's electrical grid.

The future of our production of GOES was at risk under the initial draft of the DOE's new emissions standard as proposed, last year. If adopted as initially proposed, the new standard would have effectively replaced the use of GOES in all transformers used in the United States with made in Japan amorphous metal.

Fortunately, the DOE heard what Cliffs and our American clients, the company is producing transformers in the United States, we're telling them. And with great help from elected officials like Senator Sherrod Brown of Ohio, Senator Bob Casey of Pennsylvania, and Governor Josh

Shapiro of Pennsylvania, as well as Representative Mike Kelly from Butler County in Pennsylvania and Representative Chris Deluzio of Pittsburgh, Pennsylvania, just to name a few, a more reasonable standard was adopted.

With that, our customers will continue to be in business, and they will continue to use GOES to produce the transformers our country needs.

By the way, there is pent-up demand for transformers in the United States, and that's a great opportunity to produce more transformers and to generate more jobs for American workers.

We expect to see significant investment from our customers in this important piece of infrastructure, and we must produce more made in USA transformers. That's totally viable because Cliffs already has enough additional steel producing capacity for GOES to deploy in Butler, Pennsylvania and Zanesville, Ohio.

Our other major move this quarter, was announcing the indefinite idle of our Weirton facility, which officially ceased production on April 11th. Over the past three years, Weirton's average annual contribution to our EBITDA was a negative $100 million, due largely to unfairly traded imports of tinplate products.

In January, the Department of Commerce recommended antidumping and countervailing duties on some of these imports, which would have mitigated this issue. But in February, the International Trade Commission, in a totally surprising decision, reversed the Department of Commerce recommendation, allowing for low-priced imports to continue to flow into the United States.

As a result, we had no choice but to exit the tinplate market, leaving more than 900 Weirton employees without a job. Some of these employees elected to retire, and we were able to offer the impacted workers employment at other Cliffs facilities. As of today, we have been able to relocate over 100 employees to other Cliffs locations.

Our GAAP loss in Q1 is primarily driven by the approximately $170 million in one-time charges taken at Weirton, mainly employee support costs, along with asset impairments and other expenses.

Clearly, this was an eventful quarter for us. Our automotive business carried the day for us, once again, as the automotive sector in the US continues to improve, growing for the fourth consecutive year.

Our customers need us for our best-in-class quality, delivery performance, customer service and technical expertise. Buying steel from other suppliers is just a price-driven decision for each one of the individual car manufacturers, but not all car manufacturers are willing to bet their

performance on less competent suppliers just to save a few bucks per ton. Some are willing to do so and these ones will be treated by Cleveland-Cliffs, accordingly. Message delivered.

On the flip side, service center business lagged on both volume and price during the past quarter, impacting our production volume. Demand has since returned, and we have had success in implementing our recent price increase. This should support prices and shipments above the 4 million-ton level in Q2.

With that, I will turn it over to Rob for Q&A.

Operator

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, today, you may press "*", "1" from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press "*", "2" if you would like to remove your question from the queue. For participants that are using speaker equipment, it may be necessary to pick up your handset, before pressing the star keys.

One moment, please, while we pull for questions. Once again, that's "*", "1". Thank you.

Our first question, today is from the line of Lucas Pipes with B. Riley Securities. Please proceed with your question.

Lucas Pipes

Thank you very much, Rob. Good morning, everyone. Lourenco, you said the option that Nippon essentially acquires the non-union assets and you acquire the union assets is dead. And I wondered, is there anything that could revive that option? Any thoughts on that? Thank you very much.

Lourenco Goncalves

Thank you for the question, Lucas, and good morning to you. By the way, I said that I offered this option, but I'm assuming that between Citibank and the bank representing Nippon Steel and Ropes & Gray, the law firm representing Nippon Steel, they were able to at least deliver the message to Nippon Steel because Nippon Steel never had the courtesy to reply to my offer, to sit down and discuss.

So, I'm just assuming that they said what the--they did what they said they had done to deliver the proposal to Nippon Steel. That said, yeah, the proposal is gone because at this point, the President of the United States already said what he's going to do. He's not a dictator. He needs to wait for the process to run.

And then he will do what he already promised, publicly, to the workers of the USW, to the President of the USW, Dave McCall, and he has repeated in public situations. So it's game over.

I cannot go against the word of the President of the United States. So, therefore, my option is totally 100% off the table.

Lucas Pipes

That's very clear. Thank you. Thank you for that. And so, I think in the prepared remarks, you mentioned cost reduction in Q2. Could you remind me, or us, of those? And also, what would be the impact on margins in the current steel environment in Q2 and also for the rest of the year? And as you think about free cash flow, any portion that would go towards deleveraging off the kid of higher Q1 levels or 100% towards the buyback? Thank you very much.

Celso Goncalves

Yeah, sure. Hey, Lucas. Good morning. As it relates to costs, we indicated that from 2023 to 2024, we're going to achieve a $30 per ton decrease, which equates to kind of a $500 million savings on an annualized basis. And that's going to come from, primarily, lower cost coal. We negotiated our coal contracts very well, lower natural gas, lower alloy costs. So these are the three primary drivers that are going to help our costs.

As it relates to Q2, specifically, costs are going to be down $20 a ton. You'll start to see the full benefit from these lower coal contracts. Natural gas has also been lower than we expected, and the mix is going to be slightly less value-add here in Q2, which is going to help costs.

As it relates to your other question, I believe you asked in terms of free cash flow and deleveraging. I think we made it pretty clear that share buybacks would be the number one priority. I made that abundantly clear in the last call. But obviously, if we do see opportunities to buy back bonds in the open market, we'll look to do that as well. We didn't have that opportunity during Q1, because our bonds were, essentially, all trading above par, and we had already paid down the entire balance of the ABL.

We're giving ourselves this flexibility to use a little bit more leverage within our existing rating category to buy back more stock. But if there are opportunities to buy back bonds in the open market, we'll look to do that, as well.

Lucas Pipes

Sounds good. Thank you very much for all the color, Lourenco and team. Continued best of luck. Thank you.

Lourenco Goncalves

Thank you, Lucas. Appreciate it.

Operator

Our next question is from the line of Bill Peterson with JPMorgan. Please proceed with your questions.