Nucor: Between Cyclical Headwinds And Secular Tailwinds (NYSE:NUE)

Introduction

What about Nucor Corp. (NYSE:NUE)? This is one of the questions I was asked a lot in prior weeks – especially after covering its smaller peer Cleveland-Cliffs (CLF).

Steel stocks are currently suffering. NUE shares have lost roughly a quarter after peaking earlier this year.

While losing a quarter of equity market value isn’t great, it’s still a good performance, given the state of manufacturing expectations. Investors now expect a recession. Historically speaking, this has caused much steeper sell-offs among cyclical steel companies like Nucor.

40% to 50% stock price weakness is rather common during manufacturing recessions.

This time, however, Nucor benefits from secular tailwinds, including the massive CHIPS Act. Nonresidential construction demand is completely ignoring recession warnings, which is helping Nucor, thanks to high-value-added steel products.

Hence, in this article, we’ll take a closer look at the risk/reward at current prices.

An Unusual Recession

There are many ways to show the increasing odds of a recession. I usually cover most of them in my many macro-focused articles. In this case, I want to show you Richmond Federal Reserve manufacturing numbers, which haven’t been this bad since the pandemic. In this case, we’re looking at new manufacturing orders. While these numbers are highly volatile, they are essentially in line with the decline in other indicators like the ISM Manufacturing Index.

While the data below only goes to March, we see that the decline in economic confidence last year did not translate to lower steel orders. This is very unusual.

Needless to say, the same goes for Nucor. America’s largest steel corporation delivered a strong first quarter, as it generated roughly $1.9 billion in EBITDA and $1.1 billion in net earnings, translating to $4.45 per diluted share.

The profitability of its steel products segments and increased volumes and margins at the company’s steel mills segment contributed significantly to this performance.

While net earnings in the steel products segment were down 10% from the previous quarter, they remained 42% higher than the prior-year quarter and well above historical averages.

Shipments from steel mills increased by 18%, reaching a utilization rate of 80% in Q1 compared to 70% in the previous quarter. The raw materials segment also saw improved performance in the first quarter due to higher volumes.

Furthermore, in the second quarter, the company expects earnings from the steel mill segment to increase compared to the first quarter, driven by modestly higher shipments and improved margins, particularly in the sheet business.

However, the steel product segment’s performance is anticipated to be slightly moderate due to lower pricing offsetting the seasonal increase in volumes. The raw materials segment is expected to continue improving based on higher shipment volumes.

What’s interesting is that despite deteriorating economic growth expectations, the company’s comments make sense. After all, hot-rolled coil futures, a good benchmark of steel prices, have increased significantly since the end of last year. COMEX HRC futures are trading above 2018 highs.

Hence, Nucor wasn’t just upbeat about 2Q23, but it also remained optimistic about 2023, anticipating another strong year of earnings. Factors like federal support for infrastructure projects, clean energy investments, and positive trends in nonresidential construction, automotive, and energy sectors are expected to drive demand. Nucor’s growth strategy positions the company for long-term strength in the industry.

Nonresidential construction represents over half of Nucor’s overall mix, which comes with a deep understanding of the market and good connections with buyers.

In its 1Q23 call, the company mentioned that the demand picture for nonresidential construction is healthy and resilient. Backlogs for downstream construction products remain historically strong, with some segments experiencing a 56% increase compared to the 2017-2019 average.

Essentially, three pieces of legislation—the Infrastructure Investment Act, the Inflation Reduction Act, and the CHIPS Act—provide substantial funding and tax incentives, potentially generating up to 8 million tons of incremental steel demand per year over the decade. Needless to say, that’s a big deal.

But wait, there’s more!

Investments in clean energy are expected to add 2-3 million tons of annual steel demand, and the CHIPS Act has led to multiple steel-intensive semiconductor projects.

According to Nucor, its domestic production capabilities and low carbon footprint position the company favorably to supply steel for these projects.

Furthermore, Nucor has several large capital projects in progress to drive earnings growth, market share gains, and margin expansion in its core steelmaking businesses.

This includes the ramp-up of Nucor Steel Gallatin’s production, which is expected to reach its full run rate of 2.8 million tons during Q2, contributing to profitability in the second half of 2023.

Progress also continues with the construction of a new sheet mill in West Virginia, which is awaiting final federal permits. Once completed, the mill will have an annual capacity of 3 million tons and enhanced capabilities for high-quality, low-emission carbon steel products.

Balance Sheet & Valuation

Another (long-term) benefit is that Nucor’s balance sheet remains strong, with over $4.7 billion in cash and short-term investments at the end of the first quarter.

The company’s $1.75 billion revolving credit facility remains undrawn, which provides flexibility and resilience amid potential economic uncertainty.

Furthermore, the company’s net debt ratio remains well below 1x EBITDA. The company has a strong credit rating. Two of the three major rating agencies maintain an A- rating.

Hence, the company is able to focus on shareholder returns. During the first quarter, Nucor repurchased 2.7 million shares valued at $426 million and paid dividends of $131 million.

This represents a total return to shareholders of $557 million or 49% of net earnings. Over the last three fiscal years, Nucor has returned $7.6 billion to shareholders, which is roughly half of the net earnings for the period.

• The current NUE dividend yield is 1.5%.
• Over the past five years, the average annual dividend growth was 5.9%.
• In December 2021, the company hiked its dividend by 23.5% while announcing a $4 billion buyback plan.
• In December 2022, the company hiked its dividend by 2%.

With that said, the company’s free cash flow is expected to decline until 2024. This is caused by the normalization of steel prices after a blockbuster year in 2022 and higher capital expenditures.

In 2022, the company spent $1.9 billion on CapEx. That number is now expected to increase to $3.1 billion in 2024 before falling to $1.5 billion in 2025.

Right now, NUE is rapidly expanding its capabilities. If cyclical steel demand bottoms early next year, we could be looking at a multi-year upswing which is likely to benefit shareholders tremendously.

Valuation-wise, the stock is attractively valued. NUE is trading at 5.3x NTM EBITDA. However, that number is likely to increase (based on an unchanged stock price), as 2024 EBITDA is expected to fall by at least 20% versus 2023. That’s based on the aforementioned normalization of steel prices.

Given the bigger picture of strong secular tailwinds and mid-term cyclical headwinds, I believe that NUE is a great buy if it comes close to $100.

The problem is that there’s a likelihood that NUE won’t fall that far if economic growth bottoms soon (which wouldn’t be a bad thing).

However, that’s a risk I’m willing to take. I have close to 50% industrial exposure and 20% energy exposure. If I add new cyclical exposure, I need a great risk/reward.

The $100 to $110 range is what I consider to be a great risk/reward zone, with a decent probability that NUE’s stock price might get there if economic conditions continue to deteriorate.

Takeaway

Nucor Corp. has shown resilience in the steel industry despite challenges faced by steel stocks. While its equity market value has declined, it has outperformed expectations in a manufacturing recession. This is due to secular tailwinds, including the CHIPS Act and strong demand for high-value-added steel products in nonresidential construction.

In Q1, Nucor delivered strong financial performance, with increased volumes and margins contributing to profitability. The company’s positive outlook is supported by federal infrastructure support, clean energy investments, and promising trends in nonresidential construction.

Especially in nonresidential construction, NUE benefits from strong demand and high exposure.

Nucor maintains a strong balance sheet and is committed to shareholder returns through share repurchases and consistent dividends.

Despite near-term challenges, Nucor’s long-term prospects appear favorable. Investors looking for exposure to the industrial sector may find NUE an appealing investment choice if its stock price offers another correction opportunity.

I believe there’s a high likelihood of another buyable correction in the months ahead.