A Comparative Analysis of Two Steel Producers: Gerdau SA and Nucor

I ended up doing a ratio analysis of Gerdau SA (GGB) and Nucor (NUE) for a book I am writing, and thought it was worth showing here.

This section presents ratio analysis of Brazilian steelmaker Gerdau SA and U.S. steel producer Nucor. The reported numbers of these firms cannot be compared directly due to differences in size and currencies, therefore, it is important to create ratios for each. Investors should also consider differences in accounting standards internationally when interpreting the ratios. Furthermore, a time series analysis of each firm ratios calculated for three to five years in order to identify trends. Since many ratios require average balance sheet data, six years of data are required to compute five years of ratios. Since financial statements only contain data for two years of the balance sheet, it is necessary to either collect prior annual reports or use a data service such as Bloomberg, Baseline or Compustat.

The tables below provide summary financial data from Zacks Research Wizard, and the company financial statements for Gerdau and Nucor, respectively. Commercial databases almost always aggregate financial statement data into common categories. For example, two or three income statement line items may be aggregated into one expense category. This can improve comparability between firms but can also result in a loss of information. The analyst must consider this when interpreting ratios.

Gerdau SA

Nucor

In the following sections we examine selected ratios from the activity, liquidity, solvency and profitability categories to assess the relative performance and financial positions of Gerdau and Nucor.

Activity Ratios

It is important to remember that the activity ratios provide indicators of efficient operations. The inventory turnover ratios for Motorola (MOT) and Nokia (NOK) for 2001, using the average inventory, are as the follows:

Computed directly from this ratio is the measure of days in inventory:

It appears that Nucor is much more efficient at managing inventory. In 2006, Nucor’s inventory on hand averaged only 33.7 days versus 84.1 for Gerdau. Nucor also seems to be improving its days inventory (though lumpily) over the five-year period, while Gerdau’s has remained fairly steady. In 2006 Gerdau wrote off some inventory, causing the turnover ratios to appear better than they otherwise would have.

Nucor accounts for inventory using the last-in, first-out [LIFO] method. In a period of generally rising prices this tends to inflate COGS (higher-priced recent purchases are recorded as the cost), and reduce inventory (which consists of “older,” lower-priced product). Both aspects of LIFO accounting tend to increase turnover and reduce days inventory. Therefore, further analysis would be needed to determine whether Nucor’s ratios reflect greater efficiency or are simply accounting artifacts.

Accounts receivable turnover and days receivable indicate how these firms manage the collection of credit sales. A weakness in these two ratios as computed using financial statement data is that companies typically do not disclose credit sales separately from cash sales. Since neither Gerdau nor Nucor indicate credit sales separately, the turnover calculation is presented using total sales revenues, equivalent to assuming that all sales are made on credit .

Accounts receivable turnover:

Days sales outstanding:

Once again, Nucor appears to be doing a better job than Gerdau. Nucor requires on average 25.6 days to collect receivables, while Gerdau is taking 31.8 days. Both companies have been improving their collections over the last five years.

To examine the overall efficiency of the two firms we can consider the total asset turnover ratio:

Gerdau is generating $1.00 of revenues for every $1.00 invested in assets. Gerdau’s ratio was rather stable over the last five years. Nucor’s ratio, on the other hand, is much higher and improved dramatically during the five year period. Specifically, there was a large increase in efficiency reported in 2004. According to the MD&A section of the 2004 annual report,

Net sales for 2004 increased 82% to $11.38 billion, compared with $6.27 billion in 2003. The average sales price per ton increased 66% from $359 in 2003 to $595 in 2004, while total shipments to outside customers increased 9%.

Given that steel is a commodity, it is curious that Gerdau did not see a similar efficiency boost. It is possible that steel tariffs imposed by the U.S. in March 2002 were having an ongoing effect. A November 10, 2003 article in USA Today notes that Nucor was a strong supporter of the tariff, suggesting it did indeed benefit:

Steel producers and unions are demanding that Bush resist the WTO. “The steel industry is a test case for problems facing all sectors of U.S. manufacturing,” said Daniel DiMicco, CEO of Charlotte-based Nucor (NUE), the U.S.’s largest steel producer. “All of America is watching."

Liquidity Ratios

Examination of the short-term liquidity of each company is presented in the current ratios and the quick ratios for each company.

Current ratio:

Quick Ratio:

Both companies have generally been increasing their liquidity over the last several years, though Gerdau’s deteriorated somewhat in 2006. Nucor has consistently been more financially liquid than its peer.

Solvency Ratios

To examine the relative solvency of Gerdau and Nucor we can look at the proportion of liabilities on the balance sheet.

Debt-to-assets ratio (using total liabilities):

Debt to capital:

Both companies have been consistently reducing leverage. Care must be taken in interpreting solvency ratios. On one hand, a high level of leverage indicates a low level of solvency, however, as pointed out earlier, leverage can be beneficial if the company borrows at a rate lower than it can earn on the proceeds in its business. Given that interest rates were low, and declining during the 2002-2006 period, the reduction in leverage is somewhat curious.

Profitability Ratios

In this section we examine the ability of Gerdau and Nucor to generate profits based upon the level of assets and equity invested in the companies.

Return on assets:

Return on equity:

Return on assets measures the return generated based upon total assets invested in the firm. Both companies began with very low returns on capital and ended the period with very high returns. Such wide fluctuations are common in cyclical industries such as steel.

To further examine the trend in ROE we can look at a decomposition of ROE:

From 2002 to 2006, the increase in Gerdau’s ROE was primarily due to an improvement in operating margin and lower tax rates. This was offset by a lower leverage.

In the case of Nucor, operating margins were by far the most significant ROE driver.