Updated on January 28th, 2019 by Josh Arnold
Nucor (NUE) is the largest steel producer in the United States. It is also a Dividend Aristocrat.
Despite operating in the notoriously volatile raw materials sector, Nucor is also a remarkably consistent performer. The company has increased its annual dividend for 46 consecutive years, which qualifies it to be a member of the Dividend Aristocrats.
Nucor’s dividend consistency allows it to stand out in its sector and among the Dividend Aristocrats. There are currently just 5 Dividend Aristocrats from the materials sector. The company’s dividend is also very safe, which is a topic we explore in the following video:
This article will analyze Nucor’s investment prospects in detail to determine whether the stock currently holds appeal for long-term investors.
Nucor is the largest steel producer in the United States. The company is headquartered in Charlotte, North Carolina and has a market capitalization of $18 billion.
Nucor was not always a leader in the steel manufacturing industry. The company has a long and convoluted corporate history that can be traced back to the company’s founder, Ransom E. Olds (the creator of the Oldsmobile automobile). Olds left his own automotive company over a disagreement with shareholders to form the REO Motor Company, which eventually transformed into the Nuclear Corporation of America – Nucor’s first predecessor.
The company currently operates in three segments: Steel Mills (the largest segment by revenue), Steel Products, and Raw Materials.
Source: Investor Presentation
Nucor manufactures a wide variety of material types, including sheet steel, steel bars, structural formations, steel plates, downstream products, and raw materials. The majority of the company’s production comes from a combination of sheet and bar steel, as has been the case for many years.
The past several years have been tough on Nucor thanks to a significant global supply glut in the steel market. In addition, state-subsidized steel production in China continues to support high levels of supply and low pricing. However, there are several factors that suggest the company’s performance should improve over the next several years; these factors are discussed below.
The past several years have been a rollercoaster for Nucor. Steels prices have been highly volatile, driven primarily by a supply glut coming out of international markets specifically, China.
This has resulted in decreased production, harming Nucor’s profitability, although 2017 was certainly a strong rebound from the bottom, and 2018 was another strong year. In the 2018 third quarter, revenue increased 30% to $6.74 billion. Earnings-per-share more than doubled for the quarter. Sales volumes rose 7%, while higher prices and tax reform also contributed to earnings growth.
Tariffs on steel went into place in 2018 and have helped stabilize Nucor’s results. Whether these tariffs remain in the current form, some other form, or are eventually abolished completely remains to be seen. However, they are a net positive for Nucor at the moment.
Nucor is also likely to drive growth through acquisitions moving forward. The company has historically executed strategic bolt-on acquisitions when appropriate and has stated its goal is to continue to do so, adding mills and capacity in the process.
Nucor’s unique ability to grow dividends for over 40 years, even as a commodity producer, is due largely to its status as a low-cost producer.
Source: Investor Presentation
This has helped Nucor remain profitable and grow dividends through all economic cycles, while so many higher-cost commodity producers cannot stand the test of time.
Investors can get a sense of how quickly Nucor is likely to grow moving forward by looking at the company’s historical growth rates. Between 2001 and 2016, Nucor compounded its adjusted earnings-per-share at a rate of ~13% even though 2016 was still a year of depressed earnings for this steelmaker.
We believe that Nucor is likely to deliver just 2.5% adjusted earnings-per-share growth from this point forward, although bottom line growth will be lumpy thanks to Nucor’s presence in the cyclical materials sector. The enormous rebound in earnings seen in 2017 and 2018 has created what we believe may be close to a top in near-term earnings potential for Nucor.
Competitive Advantage & Recession Performance
Nucor is a manufacturer and distributor of a raw material: steel. Accordingly, the company is a ‘commodity business’ – one in which the single largest differentiator between competitors is price.
Warren Buffett has the following to say about commodity businesses:
“Stocks of companies selling commodity-like products should come with a warning label: ‘Competition may prove hazardous to human wealth.’” – Warren Buffett
Certainly, commodity businesses are not the most defensive businesses thanks to their cyclicality. This can be seen by looking at Nucor’s performance during the 2007-2009 financial crisis:
- 2007 adjusted earnings-per-share: $4.98
- 2008 adjusted earnings-per-share: $6.01
- 2009 adjusted earnings-per-share: net loss of $0.94
- 2010 adjusted earnings-per-share: $0.42
- 2011 adjusted earnings-per-share: $2.45
Nucor’s earnings-per-share were decimated by the financial crisis. The company is one of few Dividend Aristocrats whose earnings actually turned negative during this tumultuous time period. Earnings have only recently caught up to their pre-recession levels, although Nucor has continued to steadily increase its dividend payments.
With all this in mind, Nucor should not be viewed as a defensive investment. Investors should expect the company to suffer during economic downturns. In addition, with steel being used as a political bargaining chip internationally, investors should be aware that the company’s fortunes aren’t tied only to its own actions, but potentially also to those of external forces.
Valuation & Expected Returns
Nucor is expected to report adjusted earnings-per-share of about $7.20 in fiscal 2018. This would represent another huge leap in year-over-year earnings as 2017 earnings-per-share were just $3.59. That puts the company’s price-to-earnings ratio at just 8.2, which is obviously quite low compared to the broader market. It’s also important to compare Nucor’s current valuation to its long-term historical average, which is done below.
Based on this diagram, Nucor is currently trading at a discount to its long-term average and at a discount to the average valuation in the S&P 500.
However, the cyclicality of Nucor’s business model means that changing which year’s earnings that you use has a significant impact on the company’s valuation. Indeed, 2018’s earnings-per-share estimate likely represents the top of this cycle and thus, the stock should appear cheap, as declines in earnings are a much higher risk today than they were in past years.
Given this, using dividend yield as a valuation metric can help to inform investors’ understanding of the valuation. The current yield is 2.8%, which is roughly in-line with its historical dividend yields, although as one can see, that metric is quite volatile as well.
The share price is trading at levels it did five years ago, indicating that investors don’t find the current valuation to be all that attractive. Again, we believe it is because earnings are inflated in 2018 and are much more likely to decline in the coming years than to grow meaningfully. Accordingly, right now is probably not the best time to buy Nucor (although long-term investors should still fare reasonably well thanks to high-single-digit earnings growth and the company’s healthy ~2.8% dividend yield).
We see total annual returns of close to zero in the coming years as earnings and valuation movements are likely to offset each other, as they have in the past. Thus, the yield of 2.8% is probably the most appealing aspect for investors. Nucor would be highly vulnerable to an economic downturn, meaning investors should consider the impact of a recession before buying shares.
Nucor’s status as a Dividend Aristocrat helps it to stand out among the highly volatile materials sector. There are very few raw materials businesses that have multi-decade track records of compounding their adjusted earnings-per-share.
Nucor has a higher dividend yield than the S&P 500 Index, and the company has a long history of annual dividend increases. Nucor has a strong industry position and a healthy balance sheet.
However, the current stock valuation does not merit a buy recommendation. And, the company would be significantly affected by a recession.
For investors that are looking for raw materials exposure, we recommend waiting for a better opportunity to acquire shares of Nucor.