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Friday, March 26, 1999

An Investment Opinion
by Dale Wettlaufer

Berkshire's '97 Nucor Stake Revealed

Nucor Steel (NYSE: NUE) finished up $15/16 to $45 1/2 today on news reports that Berkshire Hathaway (NYSE: BRK.A) held 1.65 million shares of the Charlotte, North Carolina steel company at the end 1997. Investors unfamiliar with the organizational structure at Berkshire should be aware that there is more than one investment decision-maker at the company other than Chairman Warren Buffett. Vice-Chairman Charlie Munger, who is Chairman and CEO at Berkshire unit Wesco Financial (AMEX: WSC) can also autonomously allocate investment capital as can Lou Simpson at insurance unit GEICO. In addition, Berkshire has at least one other investment fund manager that shareholders know about. The bulk of investment capital is directed by Buffett and Munger, however.

That doesn't mean one should jump to conclusions about who's making the decisions at Berkshire on these things or whether Berkshire still owns any Nucor stock. Warren Buffett directly dealt with this issue in this year's letter to shareholders in the annual report. It's not a stretch of the imagination, however, to believe that Buffett and Munger did make this investment, as Berkshire owns a steel service center business, Precision Steel, through Wesco. Precision has two locations, in Franklin Park, Illinois, and in Charlotte, North Carolina.

Nucor is as interesting an industrial company as you will find and is a great story of how a company can effectively compete in a commodity business. The story of Nucor is legendary because of its Chairman Emeritus, Ken Iverson. Nucor originally was a converter of others' steel (among lots of other things), turning out joists with steel it didn't even make itself. As a failing company in 1966, it shucked off other divisions to concentrate itself. At that point, Iverson decided the company would make its own steel because U.S. Steel's prices were not satisfactory and some imports were not good quality.

As Richard Preston explains in his book about Nucor, American Steel, Iverson decided the company would get vertical: "...Iverson didn't like having to buy steel from anybody; he thought it made financial sense for Nuclear [part of the predecessor company's name] to make its own steel, and so he decided to build a small steel mill to supply bar steel to the Vulcraft [joist division] plants... He could not afford a blast furnace for smelting iron ore -- a blast furnace can easily cost $200 million -- but there was an alternative, and that was an electric arc furnace, a kettle for melting metal scrap. It was much cheaper to make steel out of melted junk than out of iron ore."

The mill was not just intended to supply Vulcraft, though. As Preston tells it, Iverson wanted to go beyond that: "He also wanted to leapfrog the American steel industry. So he equipped the mill with what were then the newest machines available -- a Whiting electric arc furnace, a continuous-casting machine built by Concast, Inc., and a Swedish rolling mill that was one of the first of its kind in the western hemisphere. The Swedish rolling mill could be operated by just one steel worker."

Thus the company's labor costs per ton of steel and its output per dollar of capital were leagues better than the integrated steel companies. It's not just margins for a mini-mill steel company, it's a better cost structure to operate in all environments. A big steel mill might be profitable at 75% capacity and over, but Nucor has been able to operate at returns on equity of just below 10% in really bad years like 1982 and over 37% in 1979. While industry titans like Bethlehem Steel limp along, clinging to areas of the steel market that could one day be taken over by the mini-mill operators, Nucor last year generated ROE of 13.4%, and that's with very little leverage.

At year-end 1998, Nucor had assets to equity of 1.56 times and debt/equity of 10.4%. Operating cash flow for 1998 was $641.9 million, up from $577.3 million the year before. Setting depreciation of plant, property, and equipment equal to maintenance capital expenditures, that's free cash flow of $388 million in 1998, up slightly from $358.6 million in 1997. That's an 8% increase year-over year on an 0.8% year-over-year decline in revenues, to $4.151 billion.

On a market cap of $3.95 billion and no net debt, that's something of an interesting value. While the company's attempt to create its own furnace feedstock, its iron carbide venture, didn't work, you know the heritage of innovation at Nucor is alive and well. The company continues to grow and continues to benefit from its lean organizational structure and excellent relationship with its employees. Nucor has never laid off a worker due to industry problems. As the Dell Computer of its times, this is one company that you should know if you're interested in American industry. The Preston book is an excellent read and definitely cleared up some questions I had as a kid who grew up in Buffalo and wondered what the hell happened to Bethlehem Steel.

As for Buffett or Berkshire buying, that's kind of an easy way for me introduce the topic of Nucor. It's interesting to know that someone at Berkshire bought these shares, but it's not really a big commitment of capital for the company. Not that this means Nucor isn't a quality investment. It's one of the best-run companies in the country when you look at its productivity relative to its industry peers. But to go out and buy just because Buffett is thought to have bought isn't really productive. What would be productive is to read Preston's book and learn about this great company.

For Nucor's financial history, click here. For an Excel spreadsheet of the company's continuing earnings performance and ROEs from 1967-1998, click here for Excel 5.0 and click here for Excel 7.0.

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