Today's Buy Opportunity: Nucor

This article is part of our Rising Star Portfolios series.

In my previous article (check it out here), I described why I thought the energy and materials sector would lead the global recovery and provided four stocks I considered buying. Today, I'll let you in on my final decision and make my first purchase for the Rising Star Real-Money Portfolio.

The steel industry is already cyclical because of swings in economic conditions and demand for products, but the global meltdown that began in December 2007 hit this segment especially hard. Steel prices collapsed and end-markets such as construction and manufacturing took big hits. There is no doubt that lower gross domestic product and stubborn unemployment numbers will drag on U.S. steelmakers; however, there have been some signs of improvement. Nucor (NYSE: NUE  ) , the largest steel manufacturer by production in the U.S., recently reported a nice turnaround in its third quarter. Posting net earnings of $23.5 million on a sales boost of more than 30%, it was one of the few domestic companies to not post a loss for the quarter.

A global recovery may not happen today, tomorrow, or even a year from now, but when consumer confidence finally returns on a massive scale, you can bet Nucor will be set up for success, and that's why I've decided to buy shares today.

Nucor fast facts

Market Capitalization $12.19 billion
Revenue (LTM) $14.93 billion
Earnings (LTM) $204.40 million
Dividend Yield 3.80%
Key Competitors U.S. Steel (NYSE: X  ) ; Commercial Metals (NYSE: CMC  ) ; AK Steel (NYSE: AKS  )

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months.

The business overview
Nucor is North America's largest recycler of steel, using scrap as its primary material; in 2009, the company recycled about 13.4 million tons of steel. It operates in three segments: steel mills, steel products, and raw materials.

Products from its steel mills include hot-rolled steel such as angles, rounds, channels, and sheet, as well as cold-rolled steel. Steel products include joists, fabricated steel, fasteners, metal building systems, grating, and wire mesh. Lastly, the raw materials segment produces DRI (direct reduced iron), a scrap substitute, at its plant in Trinidad, where energy and import costs are low. About 82% of the DRI Nucor produces is consumed by its own mills.

Nucor utilizes minimills that are among the most efficient and productive in the country. These mills can take advantage of local resources and lower labor costs, and can more easily adjust their production according to market demand for their products. The company operates about 20 US mills (12 bar, two structural, four sheet, and two plate), and is the largest structural, bar, rebar, cold finished bar, steel joist, and deck producer in North America. It also happens to be the most diversified steel producer in the country, which helps it defend itself against recessions, cyclical trends, and competition from imports.

 Check out its end-market mix:

 

Lastly, Nucor has been a technological pioneer with its patented Castrip minimills, which it considers "the most advanced steel plants in the world." These minimills instantly transform molten steel into steel sheets in just one step, significantly reducing the amount of time, space, energy, and labor needed. Compared with its most direct competitor, U.S. Steel, Nucor has lower fixed costs and can protect itself from downturns by adjusting production schedules on the fly. For instance, a typical minimill only needs to operate at 45% of capacity to break even, whereas the typical blast furnaces used by U.S. Steel need to operate at 60% to break even. This is an incredible advantage for Nucor because most other steel producers use blast furnaces and only use minimills in a supplemental fashion, if at all.

Check out this classy organization
According to Morningstar, Nucor gets an "A" for stewardship, which is no easy task. The company has all the characteristics that we love to see at the Fool -- it is shareholder-friendly, it has a history of paying dividends, and it has seasoned management. The CEO, Dan DiMicco, has been with the company for 28 years and not only has great industry experience, but has been the CEO since 2000. Nucor has extremely lean management. The front-line employees are only four layers removed from the CEO; this empowers workers to make the decisions, and they are rewarded appropriately. Nucor has no pension liability and has excellent relations with its employees, having not laid off one person during the recession while the company lost more than $200 million over one year.

In addition, Nucor continuously returns value to shareholders and allocates its capital properly: It has a higher five-year average return on equity than U.S. Steel, AK Steel, Steel Dynamics (Nasdaq: STLD  ) , and ArcelorMittal (NYSE: MT  ) . It pays a great 3.8% dividend, has paid 150 consecutive dividends, and has among the lowest payout ratio of all its peers.

The buy opportunity
Nucor has three great catalysts for growth:

  1. Domestic spending: According to the American Society of Civil Engineers, the U.S. needs about $2.2 trillion spent over the next five years on infrastructure just to stay competitive. This obviously means construction, maintenance, and repair, but also energy conservation, which Nucor employs through its steel production process.
  2. Emerging market growth: The demand for steel will continue to increase as long as countries like China and India (especially) have to build out their infrastructure. In March of this year, the Indian prime minister called for a doubling of infrastructure spending in the next five years to fix current problems and to keep pace with an extraordinarily fast-paced economy. Even though Nucor serves mostly the U.S., it will still benefit from international growth, and has said the company's goal is to increase exports to 15% of sales this year from 11% last year.
  3. Technology: Nucor will continue to benefit from the exclusive rights it holds on the Castrip technology, which helps it lower operating costs and maintain flexibility. As more plants open with this technology, Nucor will be further along compared with competitors.

The steel industry is highly leveraged to Chinese and emerging market growth because of the lack of OECD growth. Fortunately, despite concerns about a cooling Chinese economy, Chinese fixed-asset investment growth is up 25% through August and industrial production is up 17% compared with the previous year.

The bad news is that capacity utilization rates have dropped significantly and iron ore prices have jumped by more than 20% in the third quarter; average steel prices are down 15%. So what we can expect is substantial volatility in the steel markets as prices adjust to demand. However, it looks as though input costs should fall and steel prices should rise in the months ahead.

This is a great stock, and I expect that eventually, when market sentiment catches up to the fundamentals of Nucor's business, the price will hover somewhere between $50 and $55. Anticipate a few ups and downs in the interim, but if you're looking for a great stock pick and are willing to hold on for at least a year, then I think you'll be handsomely rewarded

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Jordan DiPietro doesn't own shares mentioned here. Nucor is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (50)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 08, 2010, at 5:47 PM, mpendragon wrote:

    I own a few shares of Nucor but I'm not that impressed with their prospects going forward. To give them some credit they have managed some profitability lately but I just don't see big growth ahead and here is why:

    1. Steel is very heavy and the weak dollar isn't going to do much for steel exports when we have to import expensive oil to move it. It's easer and cheaper to get it from Russia or China where they don't have to move it as far and you can pollute as much as you like.

    2. We're not going to have as much domestic steel consumption as we would during a normal growth phase because consumer demand will continue to be low unless we can get people back to work.

    3 We already have a lot of empty buildings and idled machinery so commercial demand shouldn't be too impressive.

    4. Government-funded rail and other stimulus projects are apt to be reduced or cut entirely with GOP leadership in the House and more Republican governors.

    I like the dividend but thats about it.

  • Report this Comment On November 08, 2010, at 8:58 PM, TMFPhillyDot wrote:

    @mpendragon,

    You are correct that it is cheaper for EM to get their steel elsewhere; however the majority of the company's steel stays domestic. (that's not to say that Nucor doesn't hope to change that). I guess the bottom line is whether or not you believe a recovery is inevitable at some point (as I do), and that when the recovery occurs, Nucor is better placed than any other steel producer. In addition, they have proven to be extremely resourceful in the past so I have no reason to believe the future will be any different. And as you noted, the 3.8% dividend and extremely low payout ratio leaves lots of room for improvement.

    Thanks for the comment!

    Best,

    Jordan (TMFPhillyDot)

  • Report this Comment On November 08, 2010, at 9:30 PM, MazonCreekRich wrote:

    Interesting selection; excellent analyis and write-up. How do you think NUE will fare in the event of inflation? Is it reasonable to expect that its supply costs will be somewhat more contained than its competitors', or will scrap iron prices rise in tandem with ore prices? What kind of pricing power does NUE have? Thanks!

  • Report this Comment On November 09, 2010, at 12:25 AM, mikecart1 wrote:

    I prefer X over Nucor.

  • Report this Comment On November 10, 2010, at 8:57 AM, TMFPhillyDot wrote:

    @mikcart1,

    Just out of curiosity, what is it that you like about X rather than NUE?

    Best,

    Jordan (TMFPhillyDot)

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