Nucor: A Mini-Mill Enjoying A Mini-Boom

The recent parabolic rise in steel prices caught pretty much everyone by surprise … and if you disagree with that, I’d point to the fact that roughly a quarter of U.S. steel capacity is still offline despite hot-rolled coil prices exceeding $1,000/st for several weeks. Still, fortune favors the prepared, and Nucor (NUE) is going to reap the benefits of this unexpected mini-boom in the first half of 2021 before what I expect will be a sharp correction as the restocking cycle ends and new capacity comes online.

When I last wrote about Nucor in August of 2020, I wrote that while I did still think the stock was undervalued and offered some upside, I preferred names like Steel Dynamics (STLD) and Ternium (TX) and that a more robust steel price environment would favor inferior names. Since then, Nucor has gone up about 35%, lagging Steel Dynamics’s 40% rise, Ternium’s 81% rise, and U.S. Steel’s (X) (one of the aforementioned “inferior operators”) 145% rise.

Nucor is currently trading at what I estimate to be around 3x on a spot-EV/EBITDA basis, and that’s a pretty fair peak-of-cycle multiple. I do still see a little upside from here (to around $60) and these higher prices could stick around a little longer (especially if I’m wrong/too bearish on non-resi activity), but I think buying a steel company at/near record steel prices is not generally going to work out.

 

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Nucor: A Mini-Mill Enjoying A Mini-Boom

Nucor Strapping In For The Downturn

While I preferred Steel Dynamics (STLD) and Commercial Metals (CMC) to Nucor (NUE) back in late January, Nucor has been the better performer over the last three months, outperforming Steel Dynamics by about 5% and CMC by about 10%. Over the past year, Nucor has been the laggard, but as the outlook for the steel industry has deteriorated investors seem to have switched their preferences a bit. This isn’t exactly unprecedented, as higher-quality commodity companies tend to outperform into downturns, and while both Steel Dynamics and CMC are high-quality, Nucor is still widely regarded by some investors as best-of-breed.

As far as the outlook goes, at this point I would still prefer Steel Dynamics to Nucor, but that’s just a relative valuation call. Nucor has better capex flexibility over the next few years, but it also has more at risk from longer downturns in the oil/gas and non-residential sectors, as well as more upside from infrastructure stimulus. Nucor is likely the safer call, but both have some appeal for investors with relatively bullish takes on the U.S. economy in the second half of 2020 and into 2021.

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Nucor Strapping In For The Downturn

Nucor Beats Its Self-Lowered Bar For Q4

There’s an emerging trend of Nucor (NUE) and Steel Dynamics (STLD) lowering guidance at their mid-quarter updates only to later beat those projections. Draw your own conclusions from that, but at a minimum it suggests low visibility into the business, which is why I think it’s a little funny that at least some sell-side analysts take guidance from these companies as though it were fait accompli.

As I said in my review of STLD’s earnings report, I don’t think the U.S. steel market is going to be as accommodating to these steel companies as managements are projecting. I believe underlying demand is still soft and I think the recent price surge is going to fade after the first quarter. That said, I still respect the operating quality of Nucor and I like it’s leverage to higher-value areas like long products and the consolidated U.S. rebar market.

When I last wrote on Nucor, I said that I preferred Steel Dynamics and Ternium (TX) to Nucor. Since then, both have outperformed (or performed less badly, more accurately), with roughly 5% declines to Nucor’s 14% decline. I still see better relative value in Steel Dynamics and Ternium at this point.

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Nucor Beats Its Self-Lowered Bar For Q4

Nucor Upgrading Its Mix, But Plenty Of Challenges Remain

It’s a good thing to be a darling; Nucor (NUE) continues to miss expectations and analysts continue to lower expectations, but the sell-side more or less has kept up a drumbeat of “surely it will get better from here”. Although 2019 EBITDA expectations are about 9% lower now for 2019 (and 7% lower for 2020) relative to the time of my last update, Nucor remains a consensus “Buy” call from the sell-side and the shares are up slightly from where they were at the time of that last article (albeit with a dip below $50 along the way).

With evidence accumulating to support the short-cycle slowdown thesis, I’m incrementally less positive on Nucor, and I think steel companies are going to have a harder time making these recent price hikes stick with sluggish auto demand, weakening non-residential activity, and growing weakness in a range of manufacturing and machinery markets. I do believe that Nucor is a best-in-class operator but I’m not sold on the risk-reward tradeoff at these prices; yes, the P/E ratio is in the single-digits, but that’s for a company that’s like to post negative EPS growth of around 6% over the next five years and negative 15% over the next three years.

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Nucor Upgrading Its Mix, But Plenty Of Challenges Remain

voestalpine Almost Finished With A Fiscal Year To Forget

I was tentatively bullish on voestalpine (OTCPK:VLPNY) (VOES.VI) back in December, stating, “Although I’m reluctant to play chicken with a freight train and go against such strongly negative sentiment as is dominating steel today, the valuation on voestalpine has me sorely tempted to take a flyer on the assumption that 2019/2020 won’t be as bad as the price seems to be forecasting.”

Although the shares did pretty well for a while thereafter, rising about 20% through early April, the shares have since been pounded (down about 25% from the April highs) on weak carbon steel prices in the U.S. and EU, rising input costs, and growing questions about whether voestalpine’s “high-quality strategy” and focus on value-added products really produces a differentiated full-cycle earnings or cash flow stream.

Steel is very much out of favor, but I’m still tempted by the valuation … and that’s with a below-the-Street opinion on near-term global economic growth and steel prices. With voestalpine shares trading like they were any other steel company, and at least a few 2019 headwinds unlikely to reoccur, I’m once again considering these shares as a potential buy.

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Voestalpine Almost Finished With A Fiscal Year To Forget

Ternium Beaten Up, But The Quality Is Still There

The six months since my last article on Ternium (TX) have not been kind to the steel sector in general, nor this Mexican steelmaker in particular, with the shares down about 16% and roughly doubling the decline of the sector. While the sector has been pressured by weaker prices, rising costs, and concerns about demand growth in 2019 and beyond, Ternium too has been squeezed by pricing and costs, not to mention weaker-than-expected demand in its key operating regions.

Macro factors remain my biggest worry with Ternium, as construction activity has yet to turn in Mexico and Argentina’s “recovery” is at best looking like a drawn-out process. Improving demand in Brazil should help, but global weakness in the auto industry remains a point of pressure for the company. Given Ternium’s excellent margins (even in comparison to leaders like Nucor (NUE) and Steel Dynamics (STLD) ), longer-term prospects in both Mexico and Brazil, and the valuation, this is still a name I like within the steel sector.

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Ternium Beaten Up, But The Quality Is Still There

Gerdau's Share Price Weakness May Not Be Entirely Reasonable

I was skittish about the near-term performance prospects for Gerdau (GGB) back in early December, and the shares have fallen about 10% since then – modestly underperforming a weak steel sector over that time. Gerdau’s share price performance hasn’t been helped by weaker steel prices in the U.S., nor a slower-to-develop recovery in Brazil, and costs continue to rise in the meantime.

I’m not all that bullish on the U.S. steel sector, but I think Gerdau has significantly upgraded their U.S. operations, and I’m more bullish on the prospects for Brazil’s steel sector over the next few years as the country makes a tentative economic recovery. Like Ternium (TX), I think Gerdau could be positioned to post EBITDA and FCF growth at a time when U.S. steelmakers will have more lackluster results, and a stronger recovery in Brazil could maintain investor enthusiasm for that region. I’m less bullish on Gerdau relative to the sell-side, but below $4/share, I think these shares are worth a look.

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Gerdau's Share Price Weakness May Not Be Entirely Reasonable

Steel Dynamics Has Near-Term Challenges, But The Valuation Is Getting Interesting

I was “cautious” on Steel Dynamics (STLD) back in January due to the challenges that come with descending from a cyclical peak, but it has still been among my favorite steel names for some time. To that end, I’m a little surprised that it has underperformed the sector since that last article, though another of my preferred names, Ternium (TX), has done even worse, while Nucor (NUE) has done a little better. On the other hand, a quick look at AK Steel (AKS), ArcelorMittal (MT), Gerdau (GGB), or U.S. Steel (X) and you realize it could still be worse.

I still believe this is a very well-run steel company, but I’m also still concerned about the underlying health of the U.S. short-cycle economy, the prospect of weaker demand and prices, and higher conversions costs. If that weren’t enough, there’s also the matter of meaningful U.S. capacity additions in sheet steel over the next few years. I do believe that Steel Dynamics is undervalued and might have some longer-term appeal now (particularly for investors with a more bullish outlook on the U.S. economy), but I do think Nucor has the better product mix for the next 6 to 18 months.

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Steel Dynamics Has Near-Term Challenges, But The Valuation Is Getting Interesting

ArcelorMittal Lagging On Weaker Markets And Margins

Steel hasn’t been a particularly popular sector over the past three months, with the sector down about 7% or so. Unimpressive as that is, it’s downright aspirational for ArcelorMittal (MT), which has seen its share price drop about 20% over that time, with a significant drop in just the last two weeks. Between uninspiring prices in most of its markets, higher costs, and concerning macro signs, there are plenty of contributing factors to consider.

I’ve said it before and it merits repeating – stocks don’t go up just because they’re cheap. It usually takes some other catalyst, some reason to believe that the tide is going to turn in a more positive direction, to get share prices moving, and that could be problematic for ArcelorMittal in the near term. While I believe management is running the business along generally sound lines, weakness in Europe and emerging concerns about the U.S. market are likely to stick around a bit longer and ArcelorMittal really needs some beat-and-raise quarters coupled with a stronger steel market to change sentiment.

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ArcelorMittal Lagging On Weaker Markets And Margins

Nucor Has The Right Mix And A Better Valuation

I wasn’t a big fan of Nucor (NUE) back in February, and I don’t feel like I’ve missed out on anything with the 10% move down since then. While Nucor remains one of the best operators in the steel business, prices have weakened as I expected and volume hasn’t made up the difference. What’s worse, costs are rising and I think companies in the steel sector may be counting on more volume/demand recovery in the U.S. than the economy can support.

With the downward move the shares are more interesting now. I still prefer Steel Dynamics (STLD) and Ternium (TX) (though the shares of the latter have been quite weak since February), but Nucor does seem to offer some upside on my EV/EBITDA valuation approach, and Nucor should benefit from oncoming volume/capacity increases in a still-healthy market while others are now investing for capacity that won’t come into play for years.

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Nucor Has The Right Mix And A Better Valuation

Nucor Has The Right Mix, But Will The Market Cooperate?

I continue to prefer Steel Dynamics (STLD) among U.S. steelmakers, but Nucor (NUE) has been the better performer over the past year (they're tied over the last two years, and STLD wins the five-yr comp), and the shares are up about 15% since the Christmas Eve 52-week low on renewed enthusiasm over better steel demand and pricing in 2019. I do like Nucor's comparatively stronger leverage to long products and plate (where I think prices will be noticeably better in 2019 relative to hot-rolled coil), but I think investors will need to wait until 2021/22 to see year-over-year growth in EBITDA again (on a full-year basis), and I see more that can go wrong with pricing and demand at this point than what can go right.

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Nucor Has The Right Mix, But Will The Market Cooperate?

Weaker Shipments Sap Insteel's First Quarter, And Margin Threats Remain

It didn’t take long at all for Insteel (IIIN) to show some divergence from my expectations for fiscal 2019, as the company’s first quarter came in meaningfully lower than I expected on weather-related shipment weakness in the quarter. Even so, the conditions in the market remain quite challenging, and it sounds as though the company will be sacrificing margins to maintain volume with customers in 2019 and hoping for some tariff relief.

I’m still comparatively less bullish on non-residential construction in 2019 than many, and I think that presents some risks to volumes and overall earning expectations for Insteel. While I believe this company is fundamentally well-run, the reality of competing against cheaper imported product is a difficult one, and the possibility of weaker-than-expected demand doesn’t help. I saw the possibility of 25% or more downside in my last update, and the shares are down about 15% from there. I do believe that has de-risked the investment case somewhat, but my confidence in the acumen of Insteel’s management is tempered by the ongoing risks presented by macro factors outside of their control.

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Weaker Shipments Sap Insteel's First Quarter, And Margin Threats Remain

Steel's Uncertain Outlook Certainly Complicates The Steel Dynamics Story

Steel Dynamics (STLD) continues to operate well in an increasingly challenging market, and I am relatively bullish on the quality of the management, the quality of the company, and the prospect for improving market share and valued-added mix to help offset some of the mounting challenges the sector is facing.

Cyclical stocks are always challenging to value, and I find that particularly true when the cycle starts to roll over. The market generally prices stocks in sectors like steel on the basis of next year’s EBITDA, but that gets tricky when you realize that the next year’s EBITDA is likely to be lower than this year’s, and the next, and so on. Looking at several different approaches, I think a mid-$30’s to low $40’s fair value is still valid and reasonable, but 2019 may still have some unwelcome surprises for the industry if demand starts to flag.

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Steel's Uncertain Outlook Certainly Complicates The Steel Dynamics Story

Insteel Navigating A Host Of Uncertainties, With Metal Spreads High On The List

It’s a challenging environment right now for Insteel (IIIN). Although this leading manufacturer of steel wire reinforcing products has an uncommonly good long-term track record for margins and returns on assets, equity, and capital given the cyclical nature of its business, pricing leverage has gotten tricky and non-residential construction spending finally seems to be slowing.

Down about a quarter from when I last wrote about the company, Insteel really hasn’t done any worse than large steel companies like Nucor (NUE) and Steel Dynamics (STLD) or other building material companies like Vulcan (VMC) and Martin Marietta Materials (MLM). Although the share price looks undemanding even if revenue and EBITDA do see some contraction from here, a retesting of past low multiples would represent about 25% to 33% downside risk.

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Insteel Navigating A Host Of Uncertainties, With Metal Spreads High On The List

POSCO's Share Price Seems To Be Predicting A Lot Of Doom And Gloom

Add POSCO (PKX) to the list of steel stocks with a confounding valuation, as investors seem to be pricing in a dire future that doesn’t seem fully justified by the financials. The trouble with cheap-looking valuations in commodity stocks is that you can be generally right about a “it won’t be that bad” thesis, and still see significant near-term declines as investors bail out of the sector on weaker prices and spreads.

POSCO shares look exceptionally undervalued now, so much so that I really have to second-guess what I’m missing in my modeling and analysis. While POSCO’s exposure to a weakening auto industry is a worry, as is the company’s new capex-heavy strategic plan, the market seems to be pricing in a pretty dire future for what I believe is at least a decently-run global steel major.

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POSCO's Share Price Seems To Be Predicting A Lot Of Doom And Gloom

ArcelorMittal Has Continued To Skid On Cycle And Capital Allocation Worries

Some of the best spreads in recent memory haven’t been much help to the steel sector over the past year, and now it looks like the cycle is meaningfully slowing down. With steel prices declining around the globe, apparent demand softening, and growing worries about expanding capacity, coupled with shrinking spreads and sell-side forecasts for declining EBITDA, it doesn’t look like a particularly healthy set-up for ArcelorMittal (MT).

I wasn’t bullish on ArcelorMittal back in September, even though the shares “looked cheap” by multiple metrics, and the shares have fallen nearly another 30% since then. I still can’t really bring myself to want to own these shares myself, even though once again the valuation seems harsh by most metrics I can evaluate.

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ArcelorMittal Has Continued To Skid On Cycle And Capital Allocation Worries

Despite A Host Of Challenges, Ternium Is Holding Up

Predicting how investors will react to particular pieces of news can be difficult, and I look at Mexico’s Ternium (TX) as a case in point. You might think that weak demand in Mexico, an ugly situation in Argentina, and a struggling rebound in Brazil would all be pressuring the stock, not to mention the announcement that Steel Dynamics (STLD) is planning to build a large (3Mtpa) plant that will export to Mexico, would pressure the stock, but Ternium has held up better than many others in the steel sector, including Steel Dynamics, Nucor (NUE), POSCO (PKX), and ArcelorMittal (MT).

Even with this recent run of better (or at least “not as bad”) performance, the shares don’t look expensive. While the pricing concerns that trouble me with Nucor and Steel Dynamics do apply here as well, as does the concern about buying shares into what is likely to be declining EBITDA, I believe Ternium could return to growth sooner and that valuation is even less demanding.

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Despite A Host Of Challenges, Ternium Is Holding Up

Nucor Reaping Fat Profits, But Worries Of Prices And Capacity Loom Over The Stock

The frustrating reality of investing in commodity companies/stocks is that the stocks are not always (or even often) performing their best when the company’s financials are at their best, and vice versa. While Nucor (NUE) posted an excellent set of results for the third quarter, and along with Steel Dynamics (STLD) continues to reap the benefits of robust metal spreads, the shares have basically matched the S&P with a mid-to-high single-digit decline over the past few months.

It is possible that this steel cycle may prove to be “stronger for longer”, but I believe 2018 is quite likely the peak EBITDA year for Nucor for at least a few years. Even though the shares trade for what appears to be a low forward multiple on EBITDA, it’s tough to make profits in steel stocks when prices are falling, capacity is rising, and investors have moved on to sectors that they believe have/will have better earnings momentum.

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Nucor Reaping Fat Profits, But Worries Of Prices And Capacity Loom Over The Stock

Steel Dynamics Getting No Love Despite Excellent Margins And Cash Flow

These remain tough days for the steel sector. Although protectionist policies and healthy end-markets have significantly improved the price environment for U.S. producers like Steel Dynamics (STLD), Nucor (NUE), and ArcelorMittal (MT), prices have softened and meaningful capacity expansions are now on the board. With Steel Dynamics planning the biggest expansion so far announced, there are renewed risks that this marks the peak of the cycle, even though the capacity expansion makes a lot of sense for the company for the long term.

When I last wrote about steel stocks in late September, I was concerned that the risk/perception of peaking steel prices and EBITDA would make it difficult for these stocks to get ahead, even though I thought Nucor looked a little too cheap relative to Steel Dynamics and other steel stocks. Since then, both stocks have weakened further, but Nucor has noticeably outperformed Steel Dynamics over that limited time period. The nearly 25% pullback in Steel Dynamics does make the stock more interesting today, and the “stronger for longer” bull argument could still prove valid, but this looks like a tough place to earn market-beating returns.

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Steel Dynamics Getting No Love Despite Excellent Margins And Cash Flow

Wall Street Believes Winter Is Coming For Steel Dynamics

Metal spreads have continued to improve, but steel prices in the U.S. have come off their highs and analysts are now modeling 2018 as the peak year for Steel Dynamics’ (STLD) EBTIDA for this cycle. Fading prices and fading EBITDA expectations are never a good combo for commodity companies, and although these shares have outperformed peers on a one-year and year-to-date basis, the performance in recent months has been lackluster.

I do believe that Steel Dynamics is undervalued now and I do believe this is a relatively better place to be in the steel sector, but this looks more and more like a difficult place to make money for at least the next few quarters. Protectionist measures and a healthy economy may support a “stronger for longer” steel cycle, but I think it will be hard for these shares to significantly outperformance unless pricing and/or volumes really surprise.

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Wall Street Believes Winter Is Coming For Steel Dynamics