The secular trends for steel continue to look at as the global economy moving towards that full employment inflection point. In this article, I will run you through my DCF model on Nucor (NUE) and then triangulate the result with a review of the fundamentals against Gerdau (GGB) and ArcelorMittal (MT). I find that Nucor is attractive, but not as attractive as Gerdau and ArcelorMittal right now.
First, let's start with an assumption about the top-line. Nucor finished FY2011 with $20B in revenue, which represented a 26.4% gain off of the preceding year. I model growth around 9.4% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 90% of revenue versus 2.6% for SG&A and 2.2% for capex. Taxes are estimated at around 29% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around 0.5% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 9% yields a fair value figure of $43.87 for ~12% upside. Nucor currently trades at around 12.2x my 2015 free cash flow estimate.
All of this falls within the context of strong operating performance:
First quarter of 2012 earnings of $0.46 per diluted share exceeded our guidance range of $0.30 to $0.35 per diluted share. That outperformance primarily resulted from stronger than expected shipments from our steel mills to outside customers during the month of March. Our results also benefited from approximately $0.04 per diluted share of state income tax adjustments.
From a multiples perspective, Nucor is also attractive. It trades at 16.4x past earnings but only 10.1x forward earnings. This compares to corresponding figures of 14.5x and 4.3x for Gerdau and 20.2x and 5.6x for ArcelorMittal.
Consensus estimates for Gerdau's EPS forecast that it will grow by 12.3% to $1.37 in 2012 and then by 62% and 17.6% in the following two years. Assuming a multiple of 8x and a conservative 2013 EPS of $2.18, the stock would hit $17.44 for 84.4% upside. These returns are substantial, but the company is only rated around a "hold" according to NASDAQ.
ArcelorMittal also explosive potential but, according to NASDAQ, is rated near a "strong buy". Consensus estimates for ArcelorMittal's EPS forecast that it will grow by 50% to $1.95 in 2012 and then by 67.7% and 19.9% in the following two years. Assuming a multiple of 8x and a conservative 2013 EPS of $3.23, the stock would hit $25.84 for around 50% upside. For a company that is so loved on the Street, this upside certainly merits opening a long position.
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