Weekly Watch | 2/22/2021

Commodity Supercycle:

A commodity supercycle is a sustained period of rising commodity prices supported by population growth, infrastructure expansion in emerging markets and typically occurs in high inflationary periods. In turn, these cycles power demand for industrial and agricultural commodities. With an increasing M1 money supply, expansionary fiscal policy, de-globalization/re-shoring, and a weaker US dollar waned against technological disruption, a myriad of factors suggest we should expect a higher inflationary environment in the near future. Furthermore, population shifts within the US in addition to the printing of more currency to fund economic stimulus and Biden’s infrastructure package may cost us well more than $2-3T dollars. Although it may seem premature to consider worrying about inflation, we believe investors should begin looking for hedges against a hot economy regardless. Consider scooping up commodity indexes, oil and energy equities to sweeten your portfolios. Cyclical sectors such as industrials, materials and energy can all be ways to trade expectations for faster economic growth. Since the Fed and Jerome Powell have seemingly let the market run melt forward, many analysts and strategists are finding new ways to position themselves for a sharp v-recovery coming out of the pandemic. With COVID-19 vaccinations are being rolled across the nation, many investors are debating whether a shift to an inflationary period may occur in the near future. Being ahead of this trend could prove to pay dividends for an investor, seeing as the rising prices of inflation would resonate in the markets. 

In China, increased infrastructure spending, additional rate cuts, and more delegation to local governments to support the auto industry have caused a relaxation of housing policies; all of these factors are considered signs in a positive direction for metals demand. The price of copper, often regarded as a harbinger for global economic growth, has jumped 50% to US $3/lb since March lows in 2020, while gold had set a record high of US $2,000/oz in July. Silver, uranium and other rare earths have also emerged quickly from prolonged slow periods, and we believe other commodities are fit to follow. Unless we see subsequent widespread lockdowns around the world in response to COVID-19, the strength of the iron ore, copper and gold prices have pointed to earnings upgrades for the mining sector. Currently, we believe that many of the valuations in the mining sector do not properly reflect the industry’s overall exposure to global demand regarding infrastructure and construction. Additionally, mining is also a beneficiary of the ongoing carbon transition given the demand it places on raw materials for components in solar panels, wind turbines, electric vehicles and batteries. Traditional valuation multiples, such as EV/EBITDA, show various mining stocks to be cheap relative to the market. In layman’s terms, buy the dip.  

These global factors lead us to believe that barring a major setback in the economic recovery from COVID-19, a commodity supercycle may be forecastable for the near future. It has been increasingly noticeable that there has been severe structural underinvestment in the traditional economy. Supply shortages have become so severe that nearly all commodities markets are in or close to a deficit which seems remarkable given how the second wave of COVID-19 is suppressing demand. Over the past year, we have seen a mass migration of people from the bigger cities to the country where land is cheaper. This low-interest rate environment now offsets the higher cost of construction and this transition is all we need to begin a structurally visible major shift in demand. Our bullish thesis on the US equities could possibly provide a segue into the global economy being on the brink of a new commodity supercycle as governments prepare to use a green industrial revolution to kickstart technological and societal growth following the coronavirus pandemic. 

Overstock.com (OSTK):

Overstock.com is perhaps one of the most undervalued equities in the technology/ “work from home” sector. In continuation with the liquidity thesis, we presented last week, Overstock doubled their assets and cash and cash equivalents over the year, with their liabilities ticking up only 37.5%. The company is outgrowing its balance sheet by a factor of 2 to 1, but many may chalk it up to the issuance of stock offering they completed in August. To the surprise of many, though, the issuance was welcomed and even advocated for by some activist investors to advance their Blockchain and Brokerage Systems. Yeah, you read that right: OverStock.com is beginning to undertake a FinTech Revolution of their own in creating the trading brokerage (broker/dealer) T-Zero. This platform has not been rolled out at full capacity yet, but the variety of applications is industry-defining. They offer the ability for private companies to be traded on their exchange through their own Blockchain ledger. The genius behind this move is that private companies who don't necessarily want to go public but want some cash out of their business can elect to offer it to private investors on this brokerage. There are not too many services that precisely treat your shares as a stock price rather than NAV. This platform in its best form may even pose a challenge to investment banks. Yes, you read that right. Overstock.com conglomerate can take down these investment banks. Why wouldn't every company coming forward elect to use Trade Zero as a listing for liquidity? Provided liquidity to be provided by its user base. We're already seeing the trend these past few years with the series of direct listings (including Palantir, another company under our coverage.) It's not an audacious claim to make, but perhaps a calculated and methodical one. Investment bankers are rich for a reason; companies opting for a platform such as TradeZero instead of going public could potentially save millions if the liquidity was the same.  

Along with the exciting news about TradeZero, let's consider their primary business. Over the past year, Overstock.com saw pandemic tailwinds that propped their profits to the tune of 100+%. It makes sense, given that the pandemic served as an impetus for many people to take stock in home investments. Many questioned whether they would be able to maintain their customer base and growth rate as time went on, and they have done precisely that. People like the ease, simplicity, and cost-effectiveness of Overstock and are less likely to pursue traditional means in the future. It's no mistake Overstock.com ranks fifth in online e-Commerce with titans of industry such as Target and Amazon. You got to remember, O.co is a niche company with niche product offerings. The fact they make the list speaks to their domination of the market. Their Opex is declining at a tune of 600 bps per year, with revenues increasing 11% and customer orders 70% YoY. They're exploding, and I don't think they're planning on giving up the market share they garnered via the pandemic. They're hungry for more and have the ambitions of becoming a major FinTech Provider in the FinTech Supply Chain. 

 This is threatening; now, when it comes to fruition and is running at full capacity, a year, I could easily justify a P/E Multiple of 225. The peers in the FinTech space trade at far higher PE's and is only a 100-point premium to what the true PE ratio is, which I believe largely accounts for the e-commerce business. Thus, to gain a better sense of the actual value of Overstock, taking into account their Blockchain and Broker-Dealer businesses coinciding with tailwinds garnered from the pandemic and crypto/ trading frenzy, I would put the stock price estimate at $336.00. That's an EPS of 1.49 YoY, beating their quarter this week by +.20 of the consensuses estimate at .50 per share and a PE Multiple of 225. Price in their Goddamn Blockchain! I see them outperforming expectations at their earnings result, both fundamentally and technically. If you'd like to see a more detailed analysis of Overstock.com, subscribe to our service to see our financial models and equity research reports.  

Virgin Galactic Holdings (SPCE):

Here we have a perfect example of an incredibly successful SPAC story. Virgin Galactic Holdings, originally known as Social Capital Hedosophia Holdings Corp., is an industrial, aerospace company that specializes in space flight for individuals and other persons of interest. While Virgin Galactic is still very much in its early stages, the company has its own spaceflight system with an aircraft, spaceship and rocket motor. The concept is that one day, the average citizen can take a vacation watching the Earth and Moon for a few days and return to Earth in a safe manner. Much of the hype surrounding this stock (specifically on online forums) has been surrounding the leadership team, notably tech billionaire Chamath Palihapitiya and business mogul Richard Branson. As we have seen with another successful SPAC, DraftKings (DKNG) (Michael Jordan in leadership), big names within a SPAC have the ability to gain the attention of the average investor. Cathie Wood has also announced a few weeks ago that a new Ark Space Invest Exchange-traded fund under the ticker ARKX will be created and Virgin Galactic will be a major component from what we have heard (2%). While there are many other speculative Space SPAC’s such as New Providence Acquisition or VG acquisition, they are still in their blank check phase and should be considered inferior competition for now. More competition from the likes of SpaceX, Blue Origin and Boeing should be the main focus going forward for long-term positions, but again, Virgin still has a leg up from the public investor perspective. In other news, the United States' government has taken significant steps towards space expansion. As we have just seen the other day in the news, NASA was successfully able to land a rover on Mars for the first time ever, and it seems as though space could entail a crowdfunding-like effect from the masses with its open-ended laws and possibilities. It is also worth noting the announcement of the United States’ Space Force Delta back in June of 2020, as the space warfare military branch of the government.   

Looking at some more technical and fundamentals, the stock was originally offered for roughly under $10 in late 2018, before blowing up to highs of $42. Since 2021, the stock has rebounded in a tremendous way since the recession caused by the pandemic, going from $25 to ATH of $62.8, before retracting to the $50 dollar range ahead of earnings this week. Interesting to note, but it has been one of the most heavily shorted SPAC’s ever since its launch. Historically, Virgin Galactic sells off after earnings since they tend to miss analyst expectations. This is somewhat typical for a company that has so many speculators and offers unique upside potential. Revenues and earnings expectations for this quarter are not much different from last quarter. From a fundamental perspective, they are not even close to being profitable and clearly have a long road ahead of them considering the growing operating costs, a Y-o-Y diluted EPS of –1.3% and poor Y-o-Y revenue growth. However, they do not have a lot of debt/nor long-term liabilities yet and offer a resilient capital structure thanks to the help of Chamath who gave $100 million of his own money to begin with. Most of their free cash has come from financial activities and as it stands, these cash flows accounted for almost a billion dollars. Their Book Value/Share ratio went from $0.21 to $2.39 in 2019 to $3.10 in 2020, which is certainly a positive sign of forward-looking growth. I think in general, playing Virgin Galactic with options is a good idea before or after their earnings, but not so much during them as implied volatility can decimate the premiums. However, buying shares post-earnings correction and using options from there as a hedge would be the strategy most favorable in my opinion.

Salesforce (CRM):

Throughout the pandemic, companies have adapted their business models and customer relations process to compete on the Internet. Fortunately for Salesforce, they’ve maintained its status as the global leader in the digital CRM (Customer Relation Management) space, as you can tell by its ticker. It’s easy to be long on Salesforce as they’ve achieved a 222.13 BN market cap with their hands in everything from marketing and sales to IT. Hey, a long-standing relationship with Oracle and having their name slapped on the tallest tower in San Francisco doesn’t hurt either. Not only is Salesforce bringing together workforces in the cloud, but it’s also bringing automation into the mix as well. Salesforce Research, an R&D division of the company, has been developing an AI software known as Einstein to predict outcomes. While you’re only likely to meet Einstein in your daily lives through natural language chatbots on your favorite e-commerce sites, there’s a new frontier ahead for the software in the medical field to analyze patients’ data and X-rays. For this reason, we are happy to be long on Salesforce with an incoming price target of $275 in the coming months. 

Keep in mind that Salesforce is coming off an all-time high in September after beating its Q2 EPS estimates by $0.77. Though Salesforce’s most recent earnings report was even stronger, it has been trading sideways for some time now. After bottoming out in later January, we see a lot of opportunity in Salesforce after a bad week for the SPY as a whole. If Salesforce can hold on past its earnings on Thursday, be on the lookout for a potential breakout after the $250.41 resistance level. 

Home Depot (HD):

The home improvement retail business has benefited tremendously from the pandemic, giving Home Depot (HD) and its main competitor Lowe’s (LOW) significant tailwinds to grow off. People are spending more time at home amid lockdowns and are thus more inclined to invest in home improvement products. As of February 22nd, HD is trading at 275.85 with a market cap of 294.75 BN while LOW is trading at 172.41 with a market cap of 126.31 BN. Although both equities have seen amazing growth this year, each of the companies still have space for more growth. They have both lost competition in their sector due to many smaller hardware businesses having trouble maintaining pace during the pandemic. Furthermore, customers trust Home Depot and Lowe’s because they know that they have whatever item they may need. The immense capacity of building materials and home improvement products that are offered by these two companies is unmatched. If it was hard to compete with these two companies in the home improvement sector before the pandemic, it has now become virtually impossible. Another reason to be bullish on Home Depot is that the shift to working from home will only have a positive effect on their sales. Companies such as Twitter, Square and Salesforce are allowing their employees to work from home indefinitely and people are thus renovating rooms into work and office space in order to accommodate. On top of that, these people want to leave the city and get their own house that will need home improvement supplies (since they no longer are required to work in person in the city). If interest rates continue to remain low with these tailwinds, the stock price should continue to reach new highs into the summer months.   

Home Depot has seen momentous growth this past year, but its stock price has been consolidating around $265-$290 since August. This is partially due to the incredible gains it had in the Spring and beginning of Summer. There seems to be an intermediate resistance level of $285 with a longer-term resistance level of 290. The stock price recently broke out of a week's long downtrend and touched resistance before testing the latest support level at 275. HD is a great long-term buy and should be worth a lot more in 5 years. Plus, it is a fantastic dividend stock, dividends paid have increased over 500% in the past decade. Everyone should be wary, however, of a market correction soon as treasury rates and fears of inflation rise. It is important to note that HD has had a sell-off after each of their last three earnings and they could fall back to $270 or below if that happens here again. They release their Q4 earnings pre-market on Tuesday with an expected EPS of $2.57.

Cleveland-Cliffs (CLF):

Cleveland-Cliffs (CLF) now holds the title of the largest vertically integrated producer of iron ore pellets and flat-rolled steel in North America after purchasing two major steelmakers in 2020. The acquisitions of AK steel (AKS) and ArcelorMittal USA (MT) allows Cleveland-Cliffs to vertically integrate (i.e. - control process, reduce costs and improve efficiencies) their legacy iron ore business with their quality-steel and hot-briquetted iron (HBI) production. Among Cliffs, integrated portfolio includes custom produced iron pellets, flat-rolled carbon steel, stainless, electrical, plate and other long steel products. It’s the acquisition of ArcelorMittal (MT), however, that may prove to be the most transformative for Cleveland-Cliffs, because they will be able to gain access to attractive high-end markets with a particular focus on the US automotive industry. Prior to the acquisition, ArcelorMittal accounted for more than 50% of Cleveland-Cliff's product revenue. We believe the company’s new scale and industry footprint will allow the company to make cost improvements and optimize its assets. With both companies already engaged in a strong relationship, the display of high synergistic potential, which will help overall integration, provides extended headwinds for both players moving forward. CLF, at its core, is a company that makes efficient iron ore bricks for furnaces to use less coal to power blast furnaces. Geographically, they now dominate the Great Lakes front steel industry and are revamping a product they already sell; two birds with one stone. CEO of Cliffs, Lourenco Goncalves, has stated that CLF is willing to take competitors out of the marketplace through Mergers and Acquisitions (M&A) and has a track record of openly disagreeing with analyst ratings when they reflect negatively on Cliffs stock. Lourenco Goncalves has a lot of skin in the game and is willing to protect and reward long-term shareholders. There are several key catalysts on the horizon, and let’s delve into why this year is going to be a big one for Cleveland-Cliffs.  

First, let it be known that ArcelorMittal is the largest vertically integrated steelmaker in the world (i.e. - supplying over 50% of their own steel-making materials), and their research and development continue to strive far ahead of any of its closest competitors. In 2006, the Mittal takeover of Arcelor transformed the company into the world's largest steel and mining company. Since then, MT has had an eccentric focus on becoming a faster, smarter company. More recently, MT’s decision to sell its US operations to Cliffs allowed the company to reduce debt and use the $500M of cash proceeds to repurchase shares, ultimately benefiting shareholders. ArcelorMittal has retained a large portion of Cliffs stock, which will become a debt-free income stream for MT. Although the world’s largest steel company will no longer operate in the U.S directly, ArcelorMittal will continue to operate its assets in Mexico and Canada while passing the torch to CLF here in the United States. ArcelorMittal reported Q4 earnings on February 11th and announced a GAAP EPS of $1.01 which beat the expected estimate of $0.08, approximately an 1100% increase. Around the same time, CLF announced a secondary share offering of 60M shares and 40M of which were offered by MT. Back when ArcelorMittal sold its US operations to Cleveland-Cliffs, MT got 78M shares from CLF for $4.77 each. Now, they have just unloaded 40M shares worth nearly a billion in profit, whereas CLF only sold 20M shares. Cliffs will use the additional cash to pay off long-term debt, while MT will use the profit to reinstate dividends, reinvest and repurchase shares while the company is at record low debt levels. Ultimately, this was the best move for CLF. Goncalves is taking a comprehensive approach to reducing leverage; issues 20M shares to pay off $334M of 9.875% debt, refinances $1B of secured debt to unsecured on presumably better terms. Leverage can be a huge positive if you use it to buy assets on the cheap and that was the whole point of the AKS and MT purchases near the bottom of the cycle. This leverage should begin to bear fruit with the upcoming earnings report. It is important to note that Q4 already pre-announced and won't include full MT acquisition nor Toledo HBI revenues. More importantly, we will be looking for 2021 guidance of free cash flow from fully integrated operations and how much more expensive debt can be retired. Wall Street is always watching, and if things go better than expected Cliffs will be well on its way to $50 levels in 2021 post-pandemic upswing. Have patience with this one.  

Additionally, various high-frequency economic indicators are beating initial expectations signaling a robust recovery. Demand growth for automotive vehicles, motorcycle sales, railway-freight traffic and electricity consumption are also strong. Therefore, many consumers have continued to shop for automobiles in this low-interest-rate environment. However, supply disruptions have been a result of a quicker than expected recovery in U.S. manufacturing and higher cost for materials used to make home goods, semiconductors and even automobiles. Consumers have been unable to spend their money on vacations and other forms of entertainment, and in turn, many of them have used their cash towards improvements on their homes. As car sales continued to rebound quickly through the second half of 2020, prices for some industrial commodities used in those products, such as steel and copper, have climbed to their highest levels in years. We believe steel and metals are all based on the overall recovery demand, global and domestic infrastructure investment and a weakening dollar which will increase the value of such commodities proportionally. Goncalves has even mentioned companies such as Tesla with a “technological orientation” who are gaining increased attention; you don’t think Elon understands the need for high-quality steel in order to remain at the top? American car companies are finally starting to innovate in the electric vehicle space after being dominated by global supply competitors for years. The increased demand for these materials is showing up in the manufacturer’s supply chains, as we noted in our latest weekly watch with Applied Materials. The next catalyst is soon on the horizon when the infrastructure bill is signed, which may ignite a small, yet visible commodity supercycle. Ultimately, it does not matter if it is windmills, cars, or flatware; people need steel and iron ore to make just about everything. Whether Joe Biden's infrastructure plan is fiscally smart for the country or immaterial at the given moment; all we care about is if the plan is fiscally beneficial for Cliffs shareholders, and it very well could be. 

From a technical perspective, CLF has broken out above the trendline on the weekly timeframe and is trading around its 2014 levels. This is extremely bullish because it signals that CLF may have a similar run-up that it did in 2007-2011. For a slow burner like Cliffs, the 3H timeframe may be one of the best when charting near to mid-term price movements.  

We retain a Strong Buy opinion supported by Cleveland-Cliffs competitive advantage producing iron ore pellets and steel in North America. Additionally, Cliffs announced an expanded scope of its Toledo HBI facility, increasing its capacity to 2.0 million metric tons, up from 1.6 million a year ago; we believe this project will generate strong capital returns. Cliffs’ acquisition of AKS and MT should be accretive to EPS and free cash flow moving into the summer of 2021 and beyond. Conclusively, these two acquisitions strengthened CLF’s competitive position as an automotive supplier. Note, some risks to our recommendation and target price may include worse than expected economic conditions in North America (i.e. - automotive OEM build rates), lower iron ore or steel prices, and higher input costs. On the contrary, we believe this is a longer-term play heading into the summer with CLF becoming a major US steel producer, especially if an infrastructure package is passed. Currently, the price of Cliffs stock trades around $17.75 (up 160% YoY), with a forward PE of 6.1 and a beta of 2.29. We have a 12-month target price of $33, which would value CLF shares at an EV/EBITDA of more than 10.0x, assuming $150 million in synergies each from two deals: AKS and MT. We believe the risk/reward profile of Cliffs is extremely compelling, given its strong long-term fundamentals, a promising balance sheet and top-tier management that has a focus on its expansionary capital structure.