Published by Nick McCullum on October 23rd, 2017
Nucor (NUE) is the single largest steel producer in the United States.
Despite operating in the sometimes-volatile raw materials sector, Nucor is also a remarkably consistent business performer. The company has increased its annual dividend for 44 consecutive years, which qualifies it to be a member of the Dividend Aristocrats list.
Nucor’s dividend consistency allows it to stand out in its sector and among the Dividend Aristocrats. There are currently just 5 Dividend Aristocrats in the materials sector.
This article will analyze Nucor’s investment prospects in details to determine whether the stock currently holds appeal for long-term investors.
Business Overview
Nucor is the largest steel producer in the United States. The company is headquartered in Charlottesville, North Carolina and has a market capitalization of $19.1 billion.
Nucor was not always a leader in the steel manufacturing industry. The company has a long and convoluted corporate history that can be traced back to the company’s founder, Ransom E. Olds (the creator of the Oldsmobile automobile). Olds left his own automotive company over a disagreement with shareholders to form the REO Motor Company, which eventually transformed into the Nuclear Corporation of America – Nucor’s first predecessor.
The company currently operates in three segments:
- Steel mills
- Steel products
- Raw materials
Each business unit’s contribution to 2016’s net sales can be seen in the following table.
Source: Nucor 2016 Annual Report, page 30
Nucor manufactures a wide variety of material types, including sheet steel, steel bars, structural formations, steel plates, downstream products, and raw materials. The following image shows a breakdown of Nucor’s production output by product type for fiscal 2016.
Source: Nucor 2016 Annual Report, page 28
The past several years have been tough on Nucor thanks to a significant global supply glut in the steel market. There are several factors that suggest the company’s performance should improve over the next several years. These factors are discussed below.
Growth Prospects
The past several years have been a rollercoaster for Nucor. Steels prices have been highly volatile, driven primarily by a supply glut coming out of international markets (namely, China).
This has resulted in decreases in production, harming Nucor’s profitability. In particular, 2015 was a significant down year in steel production, as shown below.
Source: Nucor 2016 Annual Report, page 17
2015 was a tough year, but the company’s performance appears to have rebounded. Moreover, there are a number of factors that should drive profitability growth for the foreseeable future.
The first is potential government intervention to shield domestic steel producers from the lower prices offered by international competitors. There have been discussions about changing steel import legislation, which would benefit domestic producers like Nucor.
Secondly, Trump’s proposed infrastructure plan should create a noticeable spike in domestic steel demand. As the largest steel producer in the United States, Nucor would be one of the major beneficiaries of such a bipartisan infrastructure investment plan.
Nucor is also likely to drive growth through acquisitions moving forward. The company has historically executed strategic bolt-on acquisitions when appropriate and has added two more businesses to its family in the past year alone.
The first was Southland Tube, a manufacturer of hollow structural section steel tubing. The purchase price was $130 million, which was an 8x multiple of EBITDA when averaged over the past five years. The deal was originally announced in December of 2016 and was executed quite quickly, closing on January 9th.
The Southland Tube acquisition was not Nucor’s only tuck-in transaction announced in the month of December. The company also announced the acquisition of Republic Conduit, a manufacturer of steel electrical conduits. That deal was nearly three times as large, costing the company $335 million. The transaction’s higher purchase price was offset by a more attractive valuation, coming in at approximately six times average EBITA. That deal was also closed quickly and closed on January 20th.
Nucor’s track record combined with the highly fragmented nature of the steel manufacturing industry means that growth via acquisitions is likely to be a recurring theme for this Dividend Aristocrat.
Investors can get a sense of how quickly Nucor is likely to grow moving forward by looking at the company’s historical growth rates. Between 2001 and 2016, Nucor compounded its adjusted earnings-per-share at a rate of ~13% even though 2016 was still a year of depressed earnings for this steelmaker. The company’s full earnings history during this time period can be seen below.
Source: Value Line
We believe that Nucor is likely to deliver at least 6%-8% adjusted earnings-per-share growth from this point forward, although bottom line growth will be lumpy thanks to Nucor’s presence in the cyclical materials sector.
Competitive Advantage & Recession Performance
Nucor is a manufacturer and distributor of a raw material: steel. Accordingly, the company is a ‘commodity business’ – one in which the single largest differentiator between competitors is price.
Warren Buffett has the following to say about commodity businesses:
“Stocks of companies selling commodity-like products should come with a warning label: ‘Competition may prove hazardous to human wealth.’” – Warren Buffett
Certainly, commodity businesses are not the most defensive businesses thanks to their cyclicality. This can be seen by looking at Nucor’s performance during the 2007-2009 financial crisis:
- 2007 adjusted earnings-per-share: $4.98
- 2008 adjusted earnings-per-share: $6.01
- 2009 adjusted earnings-per-share: net loss of $0.94
- 2010 adjusted earnings-per-share: $0.42
- 2011 adjusted earnings-per-share: $2.45
Nucor’s earnings-per-share were decimated by the financial crisis. The company is one of few Dividend Aristocrats whose earnings actually turned negative during this tumultuous time period. Moreover, Nucor’s earnings have never returned to their pre-recession highs (although the company has continued to steadily increase its dividend payments).
With all this in mind, Nucor should not be viewed as a defensive investment. Investors should expect the company to suffer during economic downturns.
Valuation & Expected Total Returns
Nucor is expected to report adjusted earnings-per-share of about $4 in fiscal 2017. This will be a significant rebound from last year’s figure of $2.48. The company’s current stock price of $59.89 is quite attractively priced relative to the rest of the broader stock market at a price-to-earnings ratio of just 15.0. It’s also important to compare Nucor’s current valuation to its long-term historical average, which is done below.
Source: Value Line
Based on this diagram, Nucor is currently trading at a discount to its long-term average and at a discount to the average valuation in the S&P 500.
However, the cyclicality of Nucor’s business model means that changing which year’s earnings that you use has a significant impact on the company’s valuation. For instance, using 2016’s adjusted earnings-per-share of $2.48 implies that Nucor is actually overvalued.
Source: Value Line
Using dividend yield as a valuation metric can help to understand this disagreement. As the following diagram shows, Nucor’s current dividend yield is below its 10-year average (which implies it is overvalued).
Source: Value Line
Nucor’s stock price agrees – it has more than doubled in price since the bottom of the steel market at the beginning of 2016. Accordingly, right now is probably not the best time to buy Nucor (although long-term investors should still fare reasonably well thanks to high-single-digit earnings growth and the company’s healthy ~2.5% dividend yield). When possible, we recommend that investors wait off on acquiring shares of this stock as better buying opportunities are likely to occur in the future.
Final Thoughts
Nucor’s status as a Dividend Aristocrat helps it to stand out among the highly volatile materials sector. There are very few raw materials businesses that have multi-decade track records of compounding their adjusted earnings-per-share.
However, the company’s valuation does not merit a buy recommendation at current prices. For investors that are looking for raw materials exposure, we recommend waiting for a better opportunity to acquire shares of Nucor.
