Cleveland-Cliffs Inc. (CLF) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. My name is Kevin, and I'm your conference facilitator today. I'd like to welcome everyone to Cleveland-Cliffs conference call to discuss its acquisition of Stelco Holdings. [Operator Instructions] 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 companies believe 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 each company's filings and news releases, including the news releases announcing the transaction which are available on each company's website. Today's conference call is also available and being broadcast at clevelandcliffs.com, where additional materials related to the transaction can be also found. At the conclusion of the call, it will be archived on each website and available for replay. Participating on today's call will be Lourenco Goncalves, Chairman, President and CEO of Cleveland-Cliffs; and Celso Goncalves, Executive Vice President and Chief Financial Officer of Cleveland-Cliffs. At this time, I'd like to turn the call over to Lourenco for his remarks. Please go ahead, sir.

Thanks, Kevin, and thanks to everyone for joining us on short notice this morning. Today is an exciting day for Cleveland-Cliffs as we are announcing our acquisition of Stelco, the steel company of Canada. We are paying CAD 70 per share of Stelco, with CAD 60 in cash and CAD 10 in Cliff's stock for a total enterprise value of USD 2.5 billion, and reflecting an attractive multiple of 4.8x Stelco's trailing 12 months EBITDA. We expect to close the transaction in the fourth quarter of this year. Upon closing, we will be keeping the Stelco name and legacy, which is rightfully so a strong source of Canadian pride. As you have noticed in the press release, the International President of the USW, Dave McCall, fully supports this deal. And for abundance of clarity, Dave McCall does not support any other deal in our space. Cliffs and Stelco have a lot in common. “Stelco” is the only steel company on the continent whose relationship with the union is similar to our own, not hostile, but rather centered around the achievement of shared growth. Stelco also has an amazing environmental track record, and their CO2 emissions intensity is in line with Cliffs, which is best-in-class among integrated companies throughout the entire world. Both cliffs and Stelco operate at a level of CO2 emissions significantly lower than all others around the world, and that includes the United States, Japan, Korea and Europe. From the other side of Lake Erie, we have admired what Alan Kestenbaum and his team have done to transform Stelco from an underperforming steel company under previous ownership into one of the highest margin steel companies in North America. At the end of the day, management matters and ownership matters. After acquiring the company out of bankruptcy, Alan and the Stelco team did exactly what needed to be done. First, they reset the relationship with the workforce and with the union. They brought back the Canadian pride and the value of the Stelco name and brand. They also made all the right investments at both Lake Erie Works and Hamilton Works, including a major blast furnace reline in 2020 and refocused the operations on what they could perfect, producing commodity-grade hot-rolled at a significant cost advantage and stay nimble by primarily participating in the spot market. As such, Stelco is a plug-and-play asset for Cleveland-Cliffs. Unlike the ArcelorMittal U.S.A. assets that we acquired in December of 2020 that needed massive investments and repair and maintenance initiatives that we executed over the last few years, this asset will be low capital intensity. Stelco will be the lowest cost and highest EBITDA margin flat-rolled assets in our entire footprint. Their current hot band cost per ton is USD 480 per net ton compared to the United States average of nearly USD 650 per ton, and that includes both integrated and mini mills. That's a major advantage we will benefit from. Giving our outlook for prime scrap pricing and the benefits we will see from the wave of manufacturing onshoring, the enforcement of our trade loss and the ongoing massive deployment of new capital in infrastructure, we expect assets like Lake Erie and Hamilton to outperform in the years to come. The cost advantages of this business are primarily: one, an extremely favorable pellet supply agreement that runs through 2028. Two, a favorable exchange rate; Three, lower health care costs due to Canada's publicly funded health care system. Four, an optimal operating layout as Lake Erie Works is the newest integrated facility in North America. And fifth, low energy rates in the province of Ontario. Combining what is a true site operation into our larger footprint, we will provide Stelco with several opportunities. For example, Lake Erie Works is constrained at the blast furnace. So the addition of our HBI to Lake Erie's blast furnace will both increase the throughput and reduce the cost structure. They have 2 of the best coke plants I have ever laid my eyes on, and we will be able to use the excess capacity to feed our own existing blast furnaces in the United States with in-house coke. We also buy a lot of the same things, refractory, rolling rods, limestone, Rio and truck freight, coal and several more high-priced items. Our largest scale in these purchases generates substantial cost savings potential. All in all, our total synergy estimate is USD 120 million in annual cost savings or 5% of target revenue, which is a number consistent with the average of precedent similar transactions. We at Cliffs have already proven our ability to overachieve our synergy targets with our previous acquisitions, and that will continue with our ownership of Stelco. On the commercial side, we are excited to play a larger role in the spot market. And this operation is perfectly aligned for that. With Cliffs standalone primarily being a supplier of steel to the automotive sector, we really like the opportunity to diversify our customer base and end market exposure. This acquisition also improves our position as the largest flat-rolled steel producer in North America. It makes us even more of a one-stop shop for all ranges of customer needs. We have funded the acquisition with 86% cash and 14% stock, keeping leverage at a very manageable level of less than 2.5x, significantly less than our leverage for most of the past decade. Given where our shares have been trading recently, we wanted to minimize dilution of our shares, which while we're still fulfilling the desires of Stelco's major shareholders to capture further upside for the available investment. With low trading activity, Stelco was an incredibly undervalued company at $2.5 billion enterprise value and a cost structure already lower than what a brand new greenfield mill would provide us, the acquisition of Stelco is a no-brainer. When the opportunity became available, we had to pursue it. Before doing so, we first had to satisfy what we know as the most important closing condition, seeking approval and support from the union, different from others that are learning through a very painful and very embarrassing death by 1,000 cuts type of process, we at Cliffs know that a deal cannot be done without union support. The current success of Stelco is directly associated to their USW-represented workforce, and they always have a seat at the table. These men and women will benefit from a dynamic, competitive and larger steelmaker that we are forming here. We are thrilled to further expand our amazing partnership with the USW into Canada, the province of Ontario and the cities of Nanticoke and Hamilton. To the employees of Stelco, I want to say loud and clear: we know what you have gone through under previous ownership prior to CCAA, but we have a 10-year track record at Cleveland-Cliffs, and we are not going to disappoint you. Cliffs currently has a presence of about 1,000 employees in Ontario scattered across 8 different operating locations, and we are excited to add another 2,400 employees to our workforce. Our track record has been one of reinvestment and job creation, including expanding our Canadian tooling and stamping employment by 26% since our acquisition of AK Steel in March of 2020. We have already made several commitments in connection with this investment, including keeping the name and legacy as well as the headquarters in Hamilton. We have committed to no layoffs and to maintaining a Canadian management team. We will continue the pace of investments that Stelco had already planned. Canada is a great place to do business, particularly in manufacturing, and we will not take our permission to operate for granted. To close this deal, Stelco will require shareholder approval, of which they have already achieved in nearly half through voting supporting agreements with 3 of their largest shareholders. We will also require regulatory approvals in both the United States and Canada, particularly antitrust review. Due to the diversity of our products and limited overlap in both geography and end market service, we do not foresee any issues from this review. The industrial logic and the strategic rationale of this transaction should be clear to everyone listening on today's call. As integrated steelmakers, our shared capabilities will allow us to generate substantial cost synergies without any impact to union jobs. Everything happens for a reason. We have clearly been pursuing value-enhancing M&A for some time now. And we found in Stelco a great partner that has aligned interest with us. On behalf of Cleveland-Cliffs and our Board of Directors, I want to thank Alan Kestenbaum and the Stelco team for being an amazing counterpart in this transaction. We can't wait to welcome Stelco's workforce to the Cliffs team. With that, I'll turn it over to Kevin for Q&A.

[Operator Instructions] Our first question today is coming from Lawson Winder from Bank of America.

Congratulations, Lourenco and team, on a very intriguing transaction. I just -- I'll keep it brief. Just 2 questions. One is, have you had any legal opinion or view from Investment Canada on how they might view these assets in light of recent indications in terms of strategic metals and more intensive reviews? That would be the first question.

Yes. Thanks, Lawson. Yes, we retained, as you saw in the press release, Canadian Counsel, is a law firm that we have experience working with, they are very competent, Blake's, and we have been working with them, and we see a very clear path and a very short and very objective process. Also, I initiated calls with the Canadian officials at very high levels inside the federal government and the provincial level on the phone yesterday, late afternoon, in the evening, and we'll continue through the beginning of this week, including meetings in person. So we're in good shape. We are covered by not only a legal opinion, but a legal strategy to get this thing done and done fast.

Okay. Fantastic. And then do you have any color on the permanent financing for this, like an idea of when -- of how that might be done, whether through bonds or term loan or revolver or whatnot and when you might come to market for something more permanent?

Yes, I'll have Celso answering that. Celso, go ahead.

Lawson, thanks for the question. Yes, what we're going to do is, obviously, we have committed financing at this point from Wells Fargo and JPMorgan. But when it comes time to do the takeout financing, what we're going to do is we're going to put in place a combination of unsecured notes as well as a term loan, and then we're going to do a small draw on the ABL. So it's -- we're going to tap into various pockets of demand, but we expect the financing to be pretty straightforward from that standpoint. Pro forma liquidity, given the ABL draw that we're contemplating, is still north of $3.5 billion. So we have a well designed, and we'll be looking to do the takeout financing at some point in the fall ahead of closing the transaction. And we're going to put in place the reason we're doing the term loan and the ABL draws because we want to have a lot of prepayable debt in the capital structure pro forma. So this is going to reprioritize cash accumulation and debt reduction. So putting in place those instruments that are prepayable with no penalty is going to help us delever post close.

Okay. If I could just fit in one more very quick question. Stelco has a 25% option on some iron ore assets owned by U.S. Steel. Is there any thought to what that could be valued at within the transaction? And that's all for me.

Yes, it has value. It has value and it was part of the package that we acquired. So yes, we will -- going forward, as we close the deal, we'll have that optionality.

Your next question today is coming from Carlos De Alba from Morgan Stanley.

Continue with the leadership in consolidating the sector in the U.S. Congrats on that. Just adding to prior discussion, can you give us more details on the synergies, expected $120 million? I mean how much is potentially from lower costs, lower mill steel expenses, lower selling expenses? Any details on what caused you think you can reduce, that would be useful.

Yes. Sure. I appreciate the congratulations, Carlos. The synergies are, in our case, when we acquire companies, they never come from employment. So that's one thing I would like to make abundantly clear. Of course, we're going to cut jobs at the top. There's no need for a CFO. So my dear friend, Paul Scherzer, the other day was joking with him about the synergy. This type of things will happen. But we are going to -- in this case specifically, we're going to keep our Canadian management team. So other executives will be all in charge, and they already mentioned to us that they would like to stay. We don't expect that we're going to be reducing too many people inside the office, in the headquarter because Stelco runs a pretty tight ship, and they are very lean. So just to put this off the table because I don't want people speculating that they are losing their jobs or anything like that because that's probably not the case, more likely than not. Well, except for a few specific cases. So the bulk, the synergies will be coming from big stuff. So we see, among the $120 million, we see $55 million from asset and CapEx optimization. We are going to be using low-cost coke from Stelco within our footprint. We're going to be using HBI, our HBI, scrap, our scrap for FPT and iron ore, we also have iron ore ourselves from our mines, at Lake Erie Works, blast furnace and BOF. We will be doing some optimization of material flows. We are expecting to put more production through Stelco in order to explore their favorable cost position, particularly related to the Canadian dollar against the U.S. dollar, the exchange rate. We also have another, let's call it, $35 million that we're expecting to get from procurement savings, and that's just pure purchasing negotiation when you increase the size of your footprint, we can negotiate more favorable terms in contracts and prices and things like that. So this will come as synergies. We're also anticipating another $20 million coming from SG&A and other administrative functions. We are also anticipating another $10 million coming from public company costs because we are not going to have duplication like we have today with 2 publicly traded comps. So that's the breakdown of the first bucket, that's $120 million. There's a cost of $30 million to achieve synergies, severance costs, contract termination fees, things like that. But overall, this is an exercise that we perfected after having done that so well, first with AK Steel and then with ArcelorMittal USA. So this number you can take to the bank, it will be achieved, $120 million.

And look, not necessarily related or strictly related to the announcement today. But you did mention that the average cost of US Steel North American steel producers is USD 650 per ton. And so it didn't escape to me that the current HRC prices is at that level or below. So does the company -- is the company planning or maybe taking down some capacity temporarily to better balance the market? And what is your views on the steel prices in North America?

So that's a lot for a single question. So let me start from the beginning. The cost structure of the United States is higher than the cost structure of Canada for a series of reasons. But there's one that is undeniable, easy to see is the relative value of the Canadian dollar against the U.S. dollar. Stelco has 70% of their cost structure in Canadian dollars, and that's a good thing. So take this as the first thing, but it's not the only thing. They operate well and they do a great job, and that helps. And others don't do as much. But here in United States, in comparable companies. So that's an advantage that we're going to inherit. On the other hand, we are going to continue to explore the benefits that we have in terms of giving them the possibility of further reduce their costs. So we are going to really do what we do so well in terms of exploring our footprint by -- or extending our ability, we call stretching the hot metal by using HBI. So HBI will be a big benefit for Stelco in terms of increasing throughput, increasing production, and also to further reduce their CO2 emissions, which, by the way, are very low, very close to ours and much lower than others here in the United States, in Japan, in Europe, because they have some peculiarities there, particularly related to the coke ovens that are very beneficial to have lower emissions. They have a cogeneration arrangement through the coke battery that at the end of the day, collects CO2 before CO2 hits the atmosphere. So we see so many positives. What else [Foreign Language] catch all questions that I did not address on capacity?

Just the...

If you're taking down capacity, no. We're not taking down capacity. We are not -- and by the way, taking down capacity happens when the economy is in disarray, prices are low and you have a footprint that's bigger than you need. Number one, we are buying this asset because we feel like this asset is needed. So there is no taking down capacity on that regard. And second, keep in mind, for the next few months, Cliffs will be operated as Cliff and Stelco will be operated as Stelco. I believe that by the time we close this deal in the fourth quarter, the market will be completely different. So this conversation about taking down capacity will not even be necessary. So I'm not operating Stelco as of today. We still have a process to go through. And by the time we close, that will be short. It will be not like 1 year saga like other deals in this space. It would be a real M&A deal done among professionals and to be sure to be objective. But by the time we close, this conversation will no longer apply.

Next question today is coming from Bill Peterson from JPMorgan. .

I guess maybe coming back to the Canadian authorities, and you mentioned you spoke to yesterday afternoon. Are you aware of any discussions the Stelco team may have already had with the authorities and any sort of, I guess, viewpoints that the authorities have shared?

Yes. Alan Kestenbaum has a very good relationship with the authorities. The authorities in Canada, Alan has always said to me that they are extremely accessible, always willing to cooperate and interact. Not that I don't have this here in the United States, I do. But in Canada, it's more -- let's say it's more common. It's more -- the availability is more universal in the country of Canada and the province of Ontario. And yesterday, I could confirm that because our first conversations were extremely constructive and I know that based on their body language in the call, that we are going to have a very objective and focused discussion to get things done there. So it's all good on that front, Bill.

Okay. And on the synergies, you kind of laid out some of the buckets, $20 million SG&A, $10 million in public costs and then obviously, more on the cost side. But can you discuss the linearity on how you achieve these synergies? Are these more back-end loaded? Just to try to kind of frame how these synergies flow through over the next year post close.

Yes, each one is different. But like, for example, the synergies on public company costs, that would be right away. As soon as we close, we get those. On the other hand, the synergies that are coming from the renewal of big purchasing contracts, they will come every time we renew contracts. The good thing is that we are going through preparation for the negotiation of this contract. If sure lucky enough to close this deal within the time frame that we are anticipating or slightly faster, it will be even easier to get these things. But all things considered we believe that we are going to have on year 1 of the acquisition, all these things in place, and we're going to be enjoying from year 1.

[Operator Instructions] Our next question is coming from Alex Hacking from Citi.

Lourenco and team, congrats on the transaction. On iron ore, would there be an additional synergy potential in 2028, when you could potentially reduce the path you supply with your own supply?

Well, Alex I appreciate your congratulations, Alex. 2028 is so far away, and we are focused now on one, closing the deal; two, operating at the best way, on the best way that we can operate after we close the deal. And third, keep in mind the third-party supply arrangement currently in place is very low cost. It's very local. So it's hard to beat the great deal that Alan Kestenbaum was able to put in place with his supplier. So we are going to be taking advantage of the contract that the supplier considered to Stelco. That was one of the attractive points for me to go get Stelco. So we know what we're doing and 2028 is far away. But we have a plan, but it's too early to be talking about that.