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Cleveland-Cliffs Inc. (NYSE:CLF) Valuation: A 36% Undervalued Opportunity?
Cleveland-Cliffs' estimated fair value is US$15.74 based on a 2 Stage Free Cash Flow to Equity calculation. The current share price of US$10.05 suggests that Cleveland-Cliffs is potentially 36% undervalued.
Analyst price target for CLF is US$13.45, which is 15% below our fair value estimate. This discrepancy raises questions about the stock's intrinsic value and whether it is fairly priced by taking into account forecast future cash flows and discounting them back to today's value.
Crunching The Numbers
We are using a 2-stage growth model, which means we take into account two stages of company growth. In the initial period, the company may have a higher growth rate, while the second stage is usually assumed to have a stable growth rate.
To start off with, we need to estimate the next ten years of cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.
We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A Discounted Cash Flow (DCF) is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value.
10-year Free Cash Flow Estimate
Here are the estimated free cash flows for Cleveland-Cliffs over the next ten years:
| Year | Levered FCF (US$ Millions) | | --- | --- | | 2025 | 356.0m | | 2026 | 534.9m | | 2027 | 539.5m | | 2028 | 547.0m | | 2029 | 556.6m | | 2030 | 567.8m | | 2031 | 580.3m | | 2032 | 593.8m | | 2033 | 608.1m | | 2034 | 623.1m |
Growth Rate Estimate Source: Analyst x2, Analyst x2, Est @ 0.86%, Est @ 1.39%, Est @ 1.76%, Est @ 2.02%, Est @ 2.20%, Est @ 2.32%, Est @ 2.41%, Est @ 2.47%
Present Value of 10-year Cash Flow (PVCF)
To calculate the present value of these cash flows, we discount them back to today's value using a cost of equity of 8.9%.
| Year | Discounted FCF (US$ Millions) | | --- | --- | | 2025 | US$327m | | 2026 | US$451m | | 2027 | US$418m | | 2028 | US$389m | | 2029 | US$363m | | 2030 | US$340m | | 2031 | US$319m | | 2032 | US$300m | | 2033 | US$282m | | 2034 | US$265m |
Present Value of 10-year Cash Flow (PVCF) = US$3.5b
Terminal Value
We now need to calculate the Terminal Value, which accounts for all future cash flows after this ten year period.
The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.6%.
Terminal Value (TV) = FCF2034 × (1 + g) ÷ (r – g)
= US$623m × (1 + 2.6%) ÷ (8.9%– 2.6%)
= US$10b
Present Value of Terminal Value (PVTV) = TV / (1 + r)10
= US$10b ÷ ( 1 + 8.9%)10
= US$4.3b
Total Value and Intrinsic Value
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$7.8b.
To get the intrinsic value per share, we divide this by the total number of shares outstanding.
Compared to the current share price of US$10.1, the company appears quite undervalued at a 36% discount to where the stock price trades currently.
Important Assumptions
The most important inputs to a discounted cash flow are the discount rate and actual cash flows. If you don't agree with these results, have a go at the calculation yourself and play with the assumptions.
A DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a full picture of a company's potential performance.
SWOT Analysis for Cleveland-Cliffs
Strengths:
- Debt is well covered by cash flow.
- Forecast to reduce losses next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Good value based on P/S ratio and estimated fair value.
Weaknesses:
- Interest payments on debt are not well covered.
- No apparent threats visible for CLF.
Conclusion
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?"
If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, the output can look very different.
What is the reason for the share price sitting below the intrinsic value? For Cleveland-Cliffs, we've compiled three relevant aspects you should look at:
- Risks: For example, we've discovered one warning sign for Cleveland-Cliffs that you should be aware of before investing here.
- Management: Have insiders been ramping up their shares to take advantage of the market's sentiment for CLF's future outlook?
- Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!