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
||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:
- 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.
- 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.
- 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