Some of our colleagues see limited upside for Nucor (NYSE:NUE) in 2007 and 2008 due to a slowing US economy. We agree that the economy is slowing down, but not Nucor.
The past three years have provided NUE with phenomenal revenue growth, due in part to rising steel prices. Approximately 15% of production goes into automobiles and appliances and another 15% to the oil and gas industry. We anticipate lower consumption in the former to be countered by higher demand in the latter. Offshore rigs are not made of plastic. Neither are the pipes for deep water wells.
We disagree with Standard & Poor's (Leo J. Larkin) regarding the 60% earmarked for construction. We agree that there is a downturn in residential construction, affecting wood and wood products. Commercial construction is actually still growing at a healthy pace. Far more steel is used today in commercial construction in comparison with residential.
The recent acquisition of Harris Steel is in anticipation of strong demand for mesh wire products. Just recently, Harris Steel completed its own acquisition of a mesh specialty company; LEC Steel Inc. This may have to do with the security fence along the US southern border.
We also disagree with colleagues regarding a possible additional increase in dividends in 2007. We anticipate that dividends will remain at $0.44 and that NUE will continue to reduce the share count by about 2.5% as in 2006.
We are not overly concerned with macro economic scenarios affecting NUE.
The way we see it is either way Nucor gains. If we go through an inflationary period, revenues and earnings will increase numerically. If we hit stagflation, volume will drop yet prices will go up, again, NUE's earnings will increase. If we have a regular recession, NUE's sales may decline as demand drops, however NUE has cushioned itself against a 5% drop via the Harris Steel acquisition. As of today, all the above scenarios have a low probability of becoming reality.
In the soft landing scenario NUE comes out ahead as well. In addition to Harris Steel contributing 3% to 2007 earnings growth, we anticipate an additional 2.9% increment through organic growth (0.4%) and better margins, due in part to better sourcing for 30% of raw material consumed.
Estimated EPS for 2007 and 2008 are $6.01 and $6.22 assuming a normal core inflation rate (less than 3.2%). Estimated 2007 ROA (return on assets) and ROE are above 19% and above 31%.
NUE 1-yr chart
Disclosure: No conflicts.