Battle tested, hard-nosed, and, at times, known to be very blunt, the top executive of the largest and oldest independent iron ore mining company in the US has been called many things in an almost 40-year career spent from one end of the steel supply chain to the other. Fearful is not one of them.
Although that remains the case, Lourenco Goncalves admits to harboring growing concerns earlier this year over the spread of Covid-19 and the ramifications of the global pandemic not only on Cleveland-Cliffs Inc.s traditional iron ore operations, but also on the pending startup of a $1-billion, 1.9-million tonne-peryear hot briquetted iron (HBI) plant in Toledo, Ohio and future plans and progress of Cliffs acquisition of Westchester, Ohio-based AK Steel.
The all-stock transaction, completed on March 13, 2020, implied a total enterprise value of approximately $3.0 billion for AK Steel and immediately transformed Cliffs into one of the largest vertically integrated producers of value-added iron ore and steel products in North America. I believe AK Steel is a diamond in the rough, the chairman, president and CEO of Cleveland-Cliffs commented on the acquisition. And we will execute. Of course, this pandemic was not in the plan, said Goncalves.
The virus really didnt scare me, he recalled in late April. What scared me was if I couldnt counter it, he said. Wasting no time and with absolutely no guidelines, Cliffs top executive and his management team set out to develop and implement a variety of countermeasures to slow the spread of the virus. Steps ranging from marking spots spaced six feet apart on the plant floor for social distancing to developing rules of engagement backed up by spot checks at the plant gate calling for employees to take their temperature at home and to stay home if the reading indicated a fever.
We acted very early in the game, Goncalves said, noting that Cliffs sent employees at work home on March 9, well ahead of Ohio Governor Mike DeWines issue on March 22 of Stay-At- Home orders for all but essential businesses, of which steel and steel-related businesses were deemed one. As Goncalves pointed out, a number of the countermeasures pioneered by Cliffs management team found their way into the guidelines published by the Buckeye State. We are very proud of that because we were able to act in a way that protected against the proliferation of this horrible disease across our operations, he noted.
Although Cliffs did not announce its intention to acquire AK Steel until early December of 2019, the roots of the transaction date back several years to when the Ohio steelmaker was evaluating its investment in, and ongoing relationship with, Magnetation LLC, a joint venture between Magnetation Inc. (50.1%) and AK Iron Resources LLC, an affiliate of AK Steel Corp. (49.9 %).
Magnetation specialized in recovering high-quality iron ore concentrate from previously abandoned iron ore waste stockpiles and tailings basins on Minnesotas iron range. Magnetation LLC filed for bankruptcy in June 2015.
A month later, AK Steel announced that it had recorded a $256.3-million write-down of its investment in Magnetation LLC. The steelmaker paid an additional $37.5 million the following year to end its iron ore pellet supply deal and sever its relationship with the one-time supplier.
When they came to Cliffs, AK Steel was still taking pellets from their subsidiary company, Magnetation, Goncalves recalls. He went to work and was able to prove to AK Steel that it was abetter business decision to buy 100% from Cliffs.
Things probably started to ignite a spark inside AK Steel and AK realized they were dealing with a business savvy company, Cleveland-Cliffs, he said. Since then, I have been watching them and preparing for this acquisition.
This is not just something that I woke up one day and thought let me buy AK Steel, Cliffs top executive emphasizes. Thats not how I operate. I had all my ducks in a row.
Among those ducks were a series of proactive financial moves including a super-sized ABL (asset-based loan). We were starting to really make headway in February, Goncalves recalls. Instead of dragging my feet, I actually accelerated the process. I had to put in place a $2-billion ABL in order to take care of the combined business of the company.
I was really afraid that if I had waited any longer, I would not be able to put in place a jumbo, $2-billion ABL, he acknowledged. That is a lot of money. He was successful in doing that and actually closed ahead of the planned date. We closed on March 13 and thats pretty much when the pandemic really began to hit hard.
When Cliffs first publically announced its intention to forward integrate into valueadded steel production, it described the proposed acquisition as delivering on a long-desired objective of a more diverse customer base as well as more predictable cash flow generation due to the contracted nature of AK Steels sales of high-end automotive steel.
At the heart of that customer base is the US auto industry, which is currently gearing up production after a widespread wave of shutdowns forced by the pandemic and is itself in the midst, Goncalves insists, of a technological and social/psychological transformation spurred by Covid-19. Although Cleveland-Cliffs was not a direct supplier to auto manufacturers prior to the AK Steel acquisition, it is by no means a stranger to the automotive market and its ups and downs.
Standing alone, Cleveland-Cliffs supplies Algoma, AK Steel, ArcelorMittal and ArcelorMittal Dofasco, Goncalves noted. Among those four companies, three have a lot of exposure to automotive. So, our exposure to automotive was already there. The difference now is that instead of being a captive victim of whatever happens in automotive, I am a very active participant in what happens in automotive, he emphasized.
Now, we are on the front line, he added. Now, we are the ones that are making the commercial decisions that will make or break not only AK Steel but Cleveland-Cliffs as a whole.
Since March 13 when the AK Steel acquisition was signed, sealed and delivered, Cliffs has made a series of decisions resulting in the temporary idling or permanent shutdown of members of its expanded family of iron ore mining, metallic and steelmaking assets. A week after the transaction was finalized, and in reaction to the spread of Covid-19, Cliffs announced plans to temporarily cease construction activity at its Toledo HBI plant, effective end-of-day March 20.
Citing market conditions, Cliffs disclosed on April 13, 2020 that it would idle production at its Northshore Mining (Michigan) and Tilden Mine (Minnesota) iron ore mining operations. The company said at the time that it would work down then current inventory levels at the two locations and continue to ship iron ore to fulfil its commercial agreements with steel customers.
Further downstream, and in direct response to the Covid-19-induced crash of the auto market, the company rushed to adjust its output of automotive steels. Because most of our exposure to automotive steel product is on a just-in-time basis, we had to make immediate adjustments through a large portion of our production, Goncalves told analysts in a May 11 conference call. As part of those efforts, steel output was curtailed at the companys Dearborn, Michigan, and Middletown, Ohio, Works and all operations ceased at Precision Partners Holding Co.s plants.
Acquired by AK Steel in August 2017 for $360 million in cash, Ontario-based Precision Partners is a leading North American producer of engineering tooling and hot and cold stamped products. It specializes in tool and die engineering and the production of complex stamped components for autos. They sell steel per part. They dont sell steel per ton, Goncalves pointed out, underscoring the value-added nature of Precision Partners business.
While the majority of the adjustments undertaken are seen as temporary, one facility the hot strip mill (HSM) at Dearborn is being permanently idled. One thing we found in due diligence is that the Dearborn hot strip mill was a weak link, Goncalves told analysts in a conference call.
Given the strength and capabilities of the Middletown Works hot strip mill, the Dearborn HSM is not necessary and sub-optimal to operate.
Three years before selling what was then its Dearborn Works to AK Steel in September 2014, Severstal North America, a subsidiary of Russian steelmaker OAO Severstal, completed a large-scale $1.2-billion modernization of the plant. Included as part of the revamp package was the installation of a new pickling line, cold tandem mill and hot dip galvanizing line. AK paid $707 million in cash (including $314 million in working capital) for the integrated steelmaking complex.
When the Dearborn Works resumes production under its new owner, the finishing facility there which Goncalves considers at par with our flagship Rockport Works will be fed with and will process hot-rolled coils produced on Middletowns hot strip mill. We estimate this improvement will save us several million dollars in annual costs even after considering the additional freight to move slabs and coils between the two plants, he told analysts.
Going forward, Goncalves said in a Q1 conference call, Cliffs wholly owned AK Steel subsidiary will be configured as:
A fully integrated steel mill in Middletown, Ohio.
Two electric-furnace-based steel mills; one in Butler, Pennsylvania, and one in Mansfield, Ohio.
One slab reducing plant in Dearborn, Michigan.
Two steel finishing plants, one in Rockport, Indiana, and one in Dearborn, Michigan, with both dedicated primarily to automotive carbon steels and other high-value-added applications.
Two finishing plants dedicated to stainless and electrical steels.
Two ERW plants dedicated to the production of tubular components for automotive and other high-end applications, operating as AK Tube LLC in Walbridge, Ohio and in Columbus, Indiana.
A network of high-tech plants dedicated to provide engineering hot and cold stamped products and assemblies for the auto sector, operating as Precision Partners Holding Co.
Missing from that list, and once considered a candidate for possible restart, was a blast furnace (BF) equipping AK Steels idled Ashland, Kentucky Works. Early on, Cliffs was mulling the possibility of relighting the BF to produce merchant pig iron for EAF consumption. A subsequent market analysis convinced Goncalves, however, that electric arc furnace (EAF) steelmakers would not be buying pig iron simply because domestically produced pig iron is available.
In other words, the EAFs would not be producing exposed parts for automotive even if they have pig iron available, because thats not the restriction to produce exposed parts, he shared a key conclusion of the market analysis. We really realized that we are getting to a point with our HBI that we are pretty much optimizing the market for EAFs, Goncalves told investors participating in a virtual annual meeting of shareholders held April 22. And when I realized that the EAFs would not be able to get there, I also realized that there was an untapped potential with AK Steel that I could develop.
While the economic and human devastation that Covid-19 has visited on the world defies measure, the pandemic brought with it several unexpected benefits for Cliffs and its newly acquired steelmaking subsidiary. Potential and already realized pluses range from an accelerated fix of AKs existing Just-In-Time (JIT) delivery system to automotive customers to a mounting deficit in industrial scrap generation expected to sweeten the prospects for the high carbon content (3%) hot briquetted iron produced at its almost completed HBI plant.
Although an exercise in due diligence convinced Gonclaves that AK Steels automotive product was good, he did see room for improvement in terms of inventory and JIT delivery. I dont think AK was worse than any of the competition, he said. But it was not up to the standard that I would like to see. The clients are very demanding.
The plan going in was to fix those inventories, an effort which would take over a year while supplying the client, he added. But due to the auto plant shutdowns forced by the pandemic, we were actually able to achieve that in 30 days.
Upstream of the finished steel shipping bay, the shutdown of the countrys automotive manufacturing plants has had a marked impact on the supply of ferrous scrap. Scrap is being consumed but it is not being generated, Goncalves sizes up the situation succinctly.
With the extended outage of the entire automotive industry, there has been no busheling scrap being generated in our country, Cliffs top executive told analysts in a May 11 conference call. This unprecedented step has tightened the market considerably and we now believe that the actual demand for our HBI will be even better than the good demand we were anticipating before the pandemic.
Although it is too early due to Covid-19 considerations to set a firm timeline for the startup of Cliffs Toledo HBI plant, once contractors are able to return to the construction site and begin work, completion of the plant is expected to take about three months. And there are customers waiting. Earlier this year, Goncalves welcomed Nucor Corp., David J. Joseph Co., Steel Dynamics Inc., Omnisource LLC, Big River Steel, North Star Blue Scope Steel and several others to Cliffs list of HBI clients.
Looking back over what Cliffs has achieved since it officially welcomed AK Steel into its corporate fold on March 13, Goncalves cited what he characterized as two great things.
One was capturing a promised $120 million in year-one savings due to synergies way ahead of schedule, Goncalves told analysts in mid-May. And we are confident the final number will be fairly higher, he went on to say.
The other was successfully convincing the US Department of Commerce to self-initiate a 232 investigation on transformer laminations and cores of grain-oriented electrical steels (GOES), transformers and transformer regulators. AK Steel is the sole producer of GOES in North America, with the market for the material in the US estimated at approximately 250,000 tons per year.
And that [the investigation] is a real game changer in comparison with what was out there prior to our acquisition of AK Steel, Goncalves claimed. What was out there, he insists, was a blatant case of circumvention.
It blows my mind that the Section 232 was not enough to preclude bad players from circumventing the trade remedy and bring electrical steel into the country, Goncalves stressed.
This blatant circumvention activity has degraded the domestic electrical steel market and now threatens the viability of Cleveland-Cliffs continuing to produce GOES, Goncalves warned in a statement.
Cash for clunkers
For all its importance to Americas national security and the countrys electrical grid, GOES runs a distant second to automotive steels in AK Steels value-added product portfolio. The automotive market is not only AKs bread and butter, it is in the midst of what Goncalves calls a moment of transformation.
It doesnt happen very often, he allowed. By and large it is a very conservative industry. But right now, automotive is going from the internal combustion engine to the electric automobile.
AK Steel Research & Innovation has been playing and will continue to play a very important role in supporting the efforts of all going into electrical vehicles EVs, Goncalves said. Through our subsidiary AK Steel, Cleveland-Cliffs is going to be a very important player in the electrical vehicle arena in the very near future, he promised.
Although Covid-19 has taken a sledgehammer to automotive output in the early months of this year, Goncalves again sees a silver lining or two delivered by the onslaught of the virus. A growing sentiment against and potential fear of using
ride-share services counts as one. The negative sentiment is expected to translate into increased auto sales, as is an emerging view of individually owned vehicles as the ultimate in personal protection equipment.
Encouraged by the restart of automotive manufacturing plants last month and what he is seeing in AK Steels order books, Goncalves has gone a step further. I have been working with my friends in Congress to re-introduce Cash-For-Clunkers again, he said.
Cash-for-Clunkers was the most important initiative implemented in the United States after the last recession, he insisted. I believe that without Cash-For-Clunkers, the outcome of that recession would have been completely different.
We are at the right time to make a big push for that, because there is nothing other than the consumer that moves the economy, he argued. It would be a good thing if we use that playbook again.
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