A breakout year could be due for this undervalued steel giant. [Read this article on our website.]( [Smart Money Monday]  May 1, 2023 One of the Most Unique Setups I've Ever Seen... My favorite commodity stock in 2021 became one of my leading ideas in 2022. And itâs still near the top of my list. Even after growing revenue by more than 10X these past few years, increasing EBITDA and free cash flow, and paying down debt, it remains unloved by the market. But the fact remains that it has one of the most unique setups Iâve ever seen⦠It also has a CEO with skin in the gameâone of my no-brainer âshortcutsâ for [finding stocks with huge upside](. And based on his remarks on the companyâs first-quarter 2023 conference call, heâs looking to own more: âIâm going to buy a lot of stock as soon as the window opens.â Thatâs what I like to hear: Strong insider ownership bodes well for a companyâs long-term upside potential. Itâs part of the reason why Iâm still so bullish on Cleveland-Cliffs Inc. (CLF)âa name longtime readers of Smart Money Monday likely will recognize. While itâs already made the leap from a subpar business to a high-quality, vertically integrated steel producer, I anticipate 2023 will be its breakout year once investors realize what renegade CEO Lourenco Goncalves has created. Where CLF Stands After Q1 Earnings Cliffs put up a solid first quarter in 2023. It grew EBITDA nearly 100% compared to the fourth quarter of 2022. This was driven off strong price increases and demand from its customers. Cliffs expects EBITDA to continue growing throughout the year, but unlike many capital-intensive businesses, Cliffs converts this EBITDA into free cash flow. For 2023, I suspect the company will generate somewhere in the range of $1.5 billion in free cash flow after interest expenses and capital expenditures. Looking at todayâs market cap of $7.7 billion, that implies Cliffs is trading at just 5X 2023 free cash flow. Thatâs way too cheap, which is great for us. I like cheap. What I really love, though, is cheap with a growth catalyst. Fortunately for Cliffs, the catalyst is right on the horizon⦠Smart Capital Allocation As I mentioned, Cleveland-Cliffs is run by CEO Lourenco Goncalves. Iâve written about Lourenco several times. I think heâs incredibly underappreciated as an operator, capital allocator, and as someone with the ability to see the future of the steel market. As it pertains to capital allocation this year, Cliffs has been explicit: A significant portion of free cash flow will be used to pay down debt. The company is sitting on around $4.5 billion in debt as of the end of Q1 2023. By the end of the year, it forecasts that number dropping to $3 billion. When a company uses its cash to pay down debt, the value accretes to the equity. Itâs the same logic with a house. A $1 million house with a $1 million mortgage has no equity value to you, the owner. If you pay down that mortgage, your net worthâyour equity valueâgoes up. The same thing applies to businesses. In 2023, Cleveland-Cliffs is a debt pay-down story. And in late 2023 or early 2024, expect to see Cliffsâ catalyst start to hit. Cliffs Will Force Its Valuation Higher The market clearly doesnât give Cliffs much credit. Again, itâs valued at just 5X free cash flow. The problem, if any, with Cliffs is that it doesnât pay a dividend. Personally, I donât care about that. But Wall Streetâs institutional investors do. Peers such Nucor Corp. (NUE), Steel Dynamics Inc. (STLD), and United States Steel Corp. (X) all pay out a dividend. I suspect Cliffs will begin paying dividends once it gets debt to that $3 billion figure. Going back to free cash flow, Cliffs should generate something like $1.6 billion in free cash flow once the debt gets to $3 billion. Less debt means less interest expense. Rough math here, but letâs assume it chooses to pay out 50% of this as a dividend. An $800 million dividend pencils out to around $1.50 per share. Today, Cliffs trades at $15. That implies a juicy 10% dividend yield. But letâs be super conservative: At a 5% dividend yield, Cliffsâ shares would be worth $30âa clean double from here. Thatâs how Iâm starting to look at Cliffs from this point. The market wonât give the company any credit or real valuation. So, Cliffs is effectively going to force the valuation higher through steady cash dividends. Tying it all together, Cleveland-Cliffs Inc. (CLF) is still a buy here when you combine its strong insider ownership, current valuation, debt pay-down story, and potential dividend payments. Thanks for reading, [Thompson Clark] âThompson Clark
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the Fed]( [Thompson Clark]Thompson Clark is a small-cap expert and value-focused investor with nearly a decade of experience in financial publishing. Thompson graduated from the Goizueta Business School at Emory University in 2010 with a focus in finance and accounting. He lives in North Carolina. He is the editor of Mauldin Economicsâ free research service, [Smart Money Monday](. Don't let friends miss this timely insightâ
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