Citigroup Initiates Cleveland-Cliffs with a ‘Buy’



Why Citigroup started off with a ‘buy’ for CLF

On June 6, Citigroup (C) analyst Daniel Knauff initiated Cleveland-Cliffs (CLF) with a “buy” rating and a target price of $11, which implies a potential upside of 27.5% from its current market price. Knauff thinks that Cliffs has “significant logistical, quality and cost advantages” to supply iron ore pellets to US steel companies. He also noted that the domestic market is seeing improved dynamics, which is mostly due to import tariffs on steel imports imposed by the Trump administration.

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The rationale for the ‘buy’ rating

As we saw in Cleveland-Cliffs Could Ride the US Tariff Wave, after many policy flip-flops, the Trump administration has finally decided to end the exemptions to all the countries initially excluded from the tariffs. After the Section 232 tariffs were imposed, the exemptions made the duties practically ineffective because two-thirds of the imports were granted a temporary exemption. The impact of tariffs on US equity markets hasn’t been as favorable as it has been for the US steel sector. The SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index (SPY) (SPX-INDEX), has risen 0.8% year-to-date after increased volatility due to tariff tantrums.

Knauff also likes Cleveland-Cliffs because it is the only major independent supplier of iron ore pellets to the domestic market, and it has secured its revenue through long-term, partially fixed pricing contracts.

Investors should note that Cliffs accounted for ~55% of the annual rated US capacity in 2017, and U.S. Steel Corporation (X) accounted for 40%. The rest of the iron ore pellet capacity is owned by other backward-integrated steel players such as AK Steel (AKS) and ArcelorMittal (MT).

Cleveland-Cliffs offers greater leverage

Citigroup also believes that Cleveland-Cliffs offers greater leverage to steel prices than minimill producers such as Nucor (NUE) and Steel Dynamics (STLD) and earns better margins than integrated companies. U.S. Steel Corporation and AK Steel are among the integrated steel producers.

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