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Could A Cut In Rates Be Good For Steel Stocks Like NUE?

|About: Nucor Corporation (NUE)
Summary

Over the last twelve months, earnings declined by -39%, while sales also declined by about -8.75%.

NUE’s Free Cash Flow is healthy, at $1.47 billion.

NUE has a debt/equity ratio of .40, which is a conservative number. Their balance sheet shows $1.48 billion in cash and liquid assets against $4.2 billion of long-term debt.

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The last week of July has been a pretty significant one for the market, despite the fact that the summer months are traditionally seen as a period of decreasing volatility and price action. A large number of large cap, S&P 500-listed companies have been reporting their earnings this week, with more to come by the end of the week. Tomorrow is also when the Fed’s Board of Governors will meet to determine whether to follow through on what most investors and analysts have to come to expect will be their first interest rate cut since 2007.

To some extent, a rate cut has already been priced into the market, which means that the market’s reaction could be muted, or even force the market to briefly go down in a classic manifestation of the “buy the rumor, sell the news” idea. In the longer-term, however, most experts seem to think lowering interest rates will give the market reason to remain mostly bullish for the foreseeable future.

A Fed-imposed cut is traditionally designed to encourage economic growth, and is usually used to counter a slowing economy. So it might seem a little odd to see rates going down when the U.S. economy is generally healthy. If the Fed does cut rates as expected, this appears to be a preventative measure to counter broader, global signs of a slowing economy, in particular the effects of tariffs imposed in the trade war between the U.S. and China that doesn’t really seem to see an end any time soon.

One of the industries that analysts predict will benefit from a reduction in interest rates will be steel producers, who will be able to borrow more cheaply, increasing their ability to produce steel products. In anticipation of the effect of tariffs, and stem the flow of cheap Chinese steel into the country, by building up inventory in 2018. That forced steel prices lower late in the year; however indications now show that inventory has been worked off, and steel prices are starting to turn back up for producer like Nucor Corp (NUE), one of the biggest steelmakers in the U.S. That could help the stock continue a bullish rally that began in June of this year and reverse its long-term trend. Adding to what looks like a positive shift in momentum for the industry is a strong fundamental profile and a nice value proposition, and I think there could be a solid long-term opportunity worth paying attention to.

Fundamental and Value Profile

Nucor Corporation (Nucor) manufactures steel and steel products. The Company produces direct reduced iron (DRI) for use in its steel mills. It operates in three segments: steel mills, steel products and raw materials. The steel mills segment produces and distributes sheet steel (hot-rolled, cold-rolled and galvanized), plate steel, structural steel (wide-flange beams, beam blanks, H-piling and sheet piling) and bar steel (blooms, billets, concrete reinforcing bar, merchant bar, wire rod and special bar quality). The steel products segment produces steel joists and joist girders, steel deck, fabricated concrete reinforcing steel and cold finished steel. The raw materials produces DRI; brokers ferrous and nonferrous metals, pig iron, HBI and DRI; supplies ferro-alloys, and processes ferrous and nonferrous scrap metal. It also processes ferrous and nonferrous metals and brokers ferrous and nonferrous metals, pig iron, hot briquetted iron (HBI) and DRI. NUE has a current market cap of $17 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined by -39%, while sales also declined by about -8.75%. In the last quarter, earnings continued to decline -18.71%, while revenues declined -3.3%. I believe these are a reflection of the effect of lowering steel prices, as just mentioned as well as the effect of tariffs. The company’s margin profile is healthy, but does show signs of deterioration; over the last twelve months, Net Income was 8.83% of Revenues but narrowed to 6.55% in the last quarter.

Free Cash Flow: NUE’s Free Cash Flow is healthy, at $1.47 billion. This is a number that has declined a bit, from a little more than $1.85 billion in the previous quarter, and that translates to a still-healthy Free Cash Flow Yield of 8.6%.

Debt to Equity: NUE has a debt/equity ratio of .40, which is a conservative number. Their balance sheet shows $1.48 billion in cash and liquid assets against $4.2 billion of long-term debt. Their healthy margin profile, along with solid cash position means that they should have no problem servicing their debt right now. If the Fed cuts rates as expected, these numbers should get even better in the months ahead.

Dividend: NUE pays an annual dividend of $1.60 per share, which translates to a useful dividend yield of about 2.85%. NUE is among a select group of stocks with a long history of stable, and increasing dividend payments.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for NUE is $35.10 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.58. Their historical average is 2.04, which means the stock is undervalue by about 28%, and provides a good reference for the stock’s long-term potential upside, which is at about $71 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: This chart displays the last two years of stock performance for NUE. Since dropping from its high at nearly $70.50 in January of 2018, the stock has followed an extended downward trend, with occasional, significant rallies to the upside followed by a turn back in the direction of the longer trend. The stock’s rally since June is a good example of that kind of rally, and it is currently at a bit of a crossroads as to whether it will turn back down in the direction of the downward trend or manage to maintain its short-term bullish strength. The stock has pushed above the 38.2% Fibonacci retracement in the last week or so; if that level now acts as support in the $56 range, it should give the stock a way to push higher, to its next most likely resistance at around $61.50, which lines up with the 61.8% retracement line. If, however, the stock can’t manage to hold support, it could easily test previous support around $50, with further downside at around $47 after that.

Near-term Keys: If the stock can show a rally off of support, and break above $56.50, there could be an interesting opportunity to buy the stock or work with call options with an eye on $61.50 as a closing target price. If, however, the stock drops below $55, consider shorting the stock or working with put options, with a plan to exit the trade at around $50. The value proposition for NUE is very interesting, and so if you don’t mind dealing a bit of volatility centered around interest rates and tariffs, there is an interesting opportunity to be had.

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