Nucor: You Either Believe In Steel Or You Don't
- Steel has been a hot topic in the news of late thanks to President Trump’s tariffs in the industry.
- Nucor has been beaten down, but we believe the fundamentals are the strongest they have been in years.
- A look at the demand and supply metrics suggest continued tailwinds.
- A simple fair value estimation suggests 15% upside with positive bias thanks to the fundamental setup.
Nucor (NYSE:NUE) is a steel manufacturer. As we all know, steel has been a hot topic in the news of late thanks to President Trump's tariffs in the industry. We are not here to debate the utility or the folly of the tariffs, however, we do know that the news has sparked waves of selling in the steel sector in recent weeks.
A few weeks ago, we highlighted Nucor as a potential long play at BAD BEAT Investing on a technical basis. In this column, we want to discuss the name in a bit more fundamental detail for the broader Seeking Alpha community to add some color to our buy rating. In general, we have a company doing a lot of things right, but getting punished with the sector through no fault of its own. If you believe in American steel, this is a play you should be aware of after the pullback we have witnessed in recent weeks.
Recent price action
Under the philosophy that we subscribe to we are looking for stocks that have been beaten down through little fault of their own, but remain fundamentally strong with technical support. The steel industry as a whole fits the bill following the selloff as a result of tariffs, but Nucor happens to be our favorite idea in the sector right now. Take a look at the action in the last 3 months:
Source: Yahoo finance
As you can see, the stock has taken a nice hit in the few weeks, and we believe that based on the fundamentals, the stock is a buy.
Who Nucor Is
Our many followers who are not up to date on steel plays, in general, may not be familiar with Nucor. You may not be aware, but Nucor is the largest mini-mill steelmaker using electric arc furnaces to melt scrap steel to produce its products. So, when people are bringing their scrap metal to junkyards, Nucor is the type of company buying that metal in bulk from the yards to put it through the furnacing process:
In fact, Nucor being the scrapper that it is bought nearly 20 million tons of scrap last year we learned in its annual report. That is pretty hefty. This volume means that Nucor has a substantial percentage of the overall steel scrap market, perhaps as high as 30%, based on our read into the scrap markets.
The company also does more than just scrapping. Nucor also makes what is known as hot briquetted iron and direct reduced iron. Essentially, these two items as well which function as steel scrap substitutes for arc furnace feedstock. Numerous raw materials can be used in the steel-making process above. The company's operations continue to flourish, in part, due to a strong economy and demand for steel.
In total, the company operates several dozen production facilities, rebar facilities, and other processing plants. The vast majority of which are located in the United States:
Sources: Investor annual summaries, investor presentations
The number of locations and activities ongoing at each are beyond the scope of this column but can be researched by interested parties here. What we want to illustrate is the significant domestic presence, which is growing as well as acknowledge that there are a few international locations as well. In short, the company has a wide reach but also has much more room to expand. The question is whether demand will continue to rise.
Steel pricing and demand
Any play here in this sector highly depends on steel prices and demand going forward. We know that by looking at steel prices over the past several months there is high volatility:
There have been some surprises on the demand side of the equation. The World Steel Association predicted a less than 1% increase in global steel demand for 2017. That prediction was simply wrong, a massive underestimate. The growth continues. For 2018, they are projecting an 8% increase in the price of steel. While seems somewhat more realistic than last year's comparison, we do know that this is due to large demand globally. Construction demand is slated to rise and accelerate through 2019.
Finished steel demand is set to rise globally. The growth is not just in China and North America:
That said, we need to be mindful that supply has started to catch up with this rising demand, and this could weigh a bit on prices.
Still, we think the demand picture offsets and supply concern as there is talk of some massive investment in U.S. infrastructure this year. Of course, until there is action, it is simply speculation, but infrastructure is a priority of both U.S. Democrats and Republicans alike. We expect more clarity as summer approaches and the federal budget is hashed out and ultimately ready to go in October. If some good bills pass, we could see an increased demand in 2019.
If demand projections pan out, we anticipate increases in production out of Nucor. That said, based on where we are now, production has been solid, with rising tonnage.
Here is a look at the total tonnage growth in 2017 as well as sales to outside customers, which we felt was more diversified than in the past:
Sources: Quarterly earnings, Nucor Annual report
As you can see, the production and sales have risen. This is in part due to higher demand as well as a better price at which the company can sell its products.
The financial data shows growth in several key metrics:
Given the volatility in pricing of steel and the varying production across quarters, the best way to look at the company in our opinion is the EBIDTA generated per ton produced. Standard revenues and earnings are fine to look at, but we think this is the most normalized metric to look at here for this company and the sector as it really accounts for a lot of moving parts in such a fast moving segment of the economy.
Total shipments were up to 21.9 million, a great 10.6% rise from last year. Using our metric of EBITDA per ton excluding any special charges, we see the metric came in at $108 versus $72 last year. This is growth that is under-appreciated right now in our opinion. We expect this strength to most certainly continue throughout 2018 as our looking into supply and demand suggests.
We are not alone on our bullish view for the sector. Since our initial buy call for the sector, two analysts happen to agree with us. Two weeks ago, Deutsche Bank and their steel analysts said that the fundamentals have not been baked into share prices. Just today at the time of this writing, Longbow analyst Chris Olin said the fundamentals are the strongest for the steel sector that they have been since 2008. We believe these supportive stances from analysts supplant our bullish view.
There are a number of positives for Nucor right now. Nucor expects the new tax package to be highly beneficial to it, allowing it to increase and accelerate investment. The new tariffs were also applauded by the Nucor CEO. We liked this particular comment:
"You also have to have a strong steel industry to have strong infrastructure. Strong infrastructure creates a strong economy; a strong economy ensures a strong national defense… We're in a very, very cyclical business. We're at a good time in the cycle right now, but I would suggest that you go back and look at the tougher years in 2009-2010 and see how much of a struggle it's been for the entire industry during those down cycles"
So, we say why not go back and look at the pain then? It is a good idea.
A simple fair value target
As for our view, we think the stock will approach $70 which would be fair value. If you are bearish on steel or the US economy, avoid this trade. We are playing it because we see a stock that is cheap and pays a strong dividend yield of 2.5% to wait.
As for our target of $70, we return to EBITDA. We believe a fair price is 7.5-8.5X a forward multiple. This puts the target range at $66 to $76, and we selected the mid-point of this range. With that said, we are looking at about 15% upside.
We believe the fundamentals, being as strong as they have been in the last ten years, support a buy here at $60-61. It is really a bet on steel and American steel as a whole. You either believe in it or you don't.
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NUE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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