Nucor Corporation (NUE), the largest U.S. steel producer by market value, is up by more than 12% since we last wrote on this steel maker in July. Although NUE trades on high multiples, there are a number of reasons that still make Nucor one of the best investment opportunities in the steel sector. The Charlotte, North Carolina, bases steel producer has strong growth prospects, solid balance sheet, attractive cost position, and with its best in class raw materials diversification strategy NUE has the potential to create long-term value for its investors.
The innovative steel producer reported 3Q13 adjusted EPS of $0.49, beating consensus estimates of $0.39 by 26%. The results didn't only beat sell-side estimates but also came better than the company's own guidance range of $0.35-$0.40 per share.
Strong U.S. auto industry has contributed to a surge in demand for steel producers including Nucor. According to Autodata Corp, carmakers are on track to make the highest annual deliveries since 2007. This has also resulted in improvement in company specific utilization rates. The utilization rates increased meaningfully to 78% from 73% in the previous quarter.
DRI Expected To Reach Profitability Quick
As the company disclosed last month, the collapse of an iron ore pellet storage dome at Nucor Steel Louisiana, has delayed the commissioning of its new Direct Reduced Iron ("DRI") into year-end. The plant was due to start production within weeks. From a process and commissioning stand point, nothing else has changed since then. The more important thing is the DRI plant is still expected to reach profitability after the first quarter and start-up costs should also begin to decline next year.
The DRI plant in Louisiana, is expected to produce 2.5 million tons of direct reduced iron every year, which makes it the largest plant of its kind in the world. Once operational it will also be the first such plant operating in the U.S. in many years.
Capital Expenditure Declining
Nucor's capital expenditure is also declining since most of the expansion projects will be completed this year. Next year capex is expected to decline to less than $1.0 billion from $1.1 in 2013, and maintenance capital is expected to be in the range of $300 to $400 million. However, due to the $700 million total commitment to the gas program, spending will remain higher than normal in the next couple of years.
As mentioned in the introduction NUE trades on high multiples but its high growth prospects, effective management through the cycle, strong balance sheet, and above-average profitability warrant high multiples.
NUE is trading at a trailing P/E of 39.0 and has a forward P/E of 16.0. It has a PEG ratio of 0.6. The largest U.S. steel producer by market value has a price/book ratio of 2.1 compared to its 5-year average of 1.8. NUE has price/sales ratio of 0.9, slightly above its 5-year average of 0.8. Lastly it has a price/cash flow ratio of 13.1, slightly below its 3-year average of 13.2. NUE also has a sector leading dividend yield of 2.9%. In comparison Steel Dynamics (STLD) has a dividend yield of 2.6%, U.S. Steel (X) of 0.9%, ArcelorMittal (MT) of 1.1%, and AK Steel (AKS) of 0.0%.
Steel Shipments Rose in September
September service data remained positive as shipments rose more than the normal increase at this time of the year. After declines in the first half of 2013, shipments per day rose at their highest pace in September. While the demand has been mixed, the lean inventories continue to support steel prices. The structural market remains relatively weak, which shows that non-residential construction is still to pick up meaningfully.
U.S. service center shipments of carbon steel rose to 3.2 million tons in September, an increase of 10.0% Y/Y. By category, year-over-year shipments increased 6.6% for flat-rolled, 2.8% for plate, and 1.9% for pipe & tubing, while shipments fell 2.9% Y/Y for bars and 2.2% for structural. Going-forward further Y/Y shipment gains are possible through the last quarter of 2013 due to both easy comps in the second half and continued rise in the Institute For Supply Management Index ("ISM") to 56.2 in September, which bodes well for volumes given the historical relationship between the two data series.
According to the Metals Service Center Institute ("MSCI"), steel inventories at the service centers totaled 2.4 months of supply ("MOS") in September, vs. 2.2 MOS in August, and vs. the average of 2.6 MOS over the past 5 years. It appears that the service centers are entering a period of re-stocking and given normal season trends, this should continue till year end. The re-stocking period is typically supportive of both steel equities and steel prices.
Investment Thesis and Conclusion
We have a buy rating on NUE. Nucor remains one of our favorite picks in the steel sector. The company benefits highly from a strong management team and it is evident from Nucor's effective margin management throughout the cycle. The company managed its operating margins better than any other steel producer through the cycle. Nucor is also boosting a strong balance sheet.
The company is also well positioned to benefit from being an innovative leader among the steel producers. It has a very effective raw material strategy, and not only can it offer strong earnings in the near term it also offers investors diversification and flexibility that assets like DRI build into the business for the future. As raw material pricing spreads grow and change over time, this innovative steel producer has the flexibility to adjust its raw material procurement strategy in order to match.
Nucor has a significant exposure to the construction end-market, and the company is well positioned to benefit significantly from recovering U.S. non-residential construction activity in 2014 and 2015. In a nutshell NUE's strong growth prospects, attractive cost position, strong balance sheet, and best-in-class raw material diversification strategy make it a very compelling investment opportunity among the North American steel producers.