Despite having only between a "hold" and a "buy" rating on the Street, in my view, Gerdau (GGB),is currently one of the most attractive steel firms. Since I first published my bullish article on the company here, the stock has gone up by 2.8% while the S&P 500 gained 5.7%. With a specialization in long-rolled (as opposed to the more economically vulnerable flat-rolled) emerging market exposure, and a dividend yield of 3.3%, Gerdau offers unsuspectingly favorable risk / reward. Assuming that its multiple will plummet to 8x and that 2012 EPS is flat to the consensus for the prior year, there is no implied downside to the stock.
From a multiples perspective, Gerdau appears cheap. It trades at only a respective 11.7x and 6.7x past and forward earnings, while competitor Nucor (NUE) trades at a respective 20.5x and 13x past and forward earnings. The Street is nevertheless currently more bullish on the latter and rates it a "buy".
At the third quarter earnings call, Nucor's CFO, Jim Frias, noted better-than-expected performance
"Third quarter 2011 earnings of $0.57 per diluted share exceeded our guidance range of $0.45 to $0.55 per diluted share. Our results increased more than eightfold over third quarter of 2010 earnings, but decreased 39% from second quarter 2011 earnings of $0.94 per diluted share...
Importantly, Nucor continues to benefit from a diversified product mix. In fact, our bar mills and deck fabricating plants delivered solid improvement over their second quarter profitability.
Earnings at our plate mills were essentially flat with the second quarter. However, the trend for the plate mills was down through the quarter due to the impact of higher imports. Our beam mill and downstream cold-finished bar businesses experienced a small decline in quarter-over-quarter results but continued to contribute solid profits".
Third quarter EPS of $0.57 beat the consensus of $0.53. However, Gerdau's third quarter EPS of R$0.41 crushed the consensus of R$0.24. Supply and demand instability, lower shipments, and inflationary inputs continue to be major concerns for Nucor. Third quarter earnings for the steel producer were below those of the second quarter due to lower metal margins for sheet and prices. As steel metal spreads decline to $18/t y-o-y, Nucor is rightfully diversifying its products and remains cautious on spending. Although the firm's upstream integration represents a major catalyst, over-exposure to soft construction markets gives me pause about the stock's appreciation.
Consensus estimates for Nucor's EPS are that it will grow by 454.5% to $2.44, and then by 27.9% and 29.5% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS estimate of $3.08, the rough intrinsic value of the stock is $34.52. This low upside of 6.2% is simply not convincing enough to open a long position, to say nothing about the wildly high bar that has been set for EPS. Moreover, if the multiple falls to that of Gerdau and 2012 EPS turns out to be just 5.4% below the consensus at $2.95, the stock has 15% downside.
Consensus estimates for Gerdau's EPS are that it will decline by 29.3% to $1.06 in 2011 and then grow by 10.4% and 51.2% in the following years. Assuming a multiple of 10x -- lower than the current one -- and a conservative 2012 EPS estimate of $1.11, the rough intrinsic value of the stock is $11.10 -- implying 41.2% upside.