Nucor Corp.'s (NUE -1.08%) earnings more than doubled year over year in the second quarter, and were also up more than 90% sequentially. In fact, Nucor even outperformed its own expectations, and CEO John Ferriola noted that this was the strongest Q2 in the giant U.S. steel producer's history.
Here are three things Nucor's management team wants you to know about the quarter and the company's future.
1. It's the economy, stupid
The steel business is highly cyclical, and industrial demand for the metal is a key driver of financial results. This is why Ferriola noted during the Q2 conference call that:
The strength of the U.S. economy was a major driver of our continued financial and operational success. Economic fundamentals began improving in the middle of 2017 and that trend has continued into this year.
This is great news on multiple fronts. For example, it means that the company can run its mills at high throughput levels, which helps to reduce margins by spreading costs over more production. In Q2, utilization was 95%, which the CEO described as "impressive." And with 22 of the company's 24 end markets experiencing strong demand today, there's a good reason to be optimistic about the rest of the year. In fact, the company currently believes that Q3 earnings will be even better than Q2's were.
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This is all good, but long-term investors should keep some perspective. The economy is doing well today, but will eventually slow down. At that point, these tailwinds will turn into headwinds for Nucor. Shareholders should be pleased with the steelmaker's recent successes, but shouldn't assume that it can enjoy a permanent plateau.
2. We're not sitting still
One of the key drivers of Nucor's long-term results is that it constantly invests in its business. That's particularly true during downturns, when it can get the best prices on acquisitions. Ferriola was compelled to point out:
As you are aware, Nucor has spent years positioning itself to take advantage of an upturn in the steel market. We have increased our workforce by 18% and invested $8 billion since the last cyclical peak in 2008.
Putting that quote a different way, to a significant degree, the recent earnings performance was by design. However, Nucor is hardly done upgrading and enhancing its business. The CEO gave a headline highlight when he said, "We are currently implementing eight exciting growth initiatives totaling more than $1.5 billion." He continued:
Completion dates for these eight projects range from 2019 through 2021. We are clearly not finished growing Nucor's long-term earnings power and we look forward to extending the company's long track record of sustainable shareholder value creation through these high-return organic investments.
In other words, Nucor is sticking with the successful long-term game plan that led to Q2's strong earnings results. While the economy may wax and wane, impacting financial performance, the steel company's focus on the long-term has remained unwavering. And the current round of investments, which consists mostly of internal efforts like plant upgrades and ground up construction, is evidence that Nucor's best days remain ahead -- even if there are short-term swings along the way.
3. We're fans of the president's tariffs
One of the major headwinds facing the U.S. steel industry in recent years has been low-cost foreign-produced steel. Steelmakers believe many exporters are subsidizing their steel industry unfairly, and dumping it onto the U.S. market at artificially low prices. In response, the domestic industry has been vigorously pursuing trade enforcement cases, many of which it has won. In that context, President Trump's hard-line stance on steel imports has been welcome. As Ferriola explained:
Imports are down more than 7% through the first half of 2018. With all tariffs going into effect in June, we expect this trend to continue. The tariffs send a clear message that the U.S. is done asking nicely for compliance with the rules of trade and is serious about demanding changes in the trade practices of other countries.
Although, broadly speaking, there are widely divergent views on the economic value and impact of tariffs, they have clearly benefited U.S. steelmakers, and their continuance further supports a strong outlook for Nucor for the rest of the year. That said, there is a lot of uncertainty and political wrangling around those tariffs, which is why the CEO added:
Importantly, however, I want to note that Nucor's strong performance is not solely due to pricing environment. Increased capacity utilization also acted as a driver of our earnings strength this quarter. Higher utilization rates are essential for the long-term sustainability of the American steel industry.
It is also why the company has the long-term goal of increasing its own internal, downstream use of the commodity steel it produces. For example, the new tubular products group was built via three acquisitions in late 2016 and early 2017, and allows Nucor to turn its commodity steel into premium-priced end products. Putting some numbers to the trends here, Nucor's internal downstream steel use increased from 8% to 19% between 2006 and 2017.
In short, Nucor is working to move up the value chain so it can increasingly play in niches where the impact of steel imports is less of an issue.
The price is high for a reason
If you are a longtime Nucor shareholder like I am, you should be pleased with Q2's results. They show that the company's long-term focus has proven itself yet again. However, potential new investors looking to add a steel company to their portfolios should be aware that the stock is relatively expensive today, trading at a price-to-book value of nearly 2.2 times. (A ratio of 1.5 or less would be a more compelling entry point based on the company's history.) That said, Nucor remains one of the best-run steelmakers in the United States, and it is worth keeping on your watch list for the next industry downturn, when the share price is likely to be more compelling.
