At the halfway mark for 2019, Nucor Corporation (NUE -0.47%) isn't having nearly as profitable a year as it did in 2018. The company announced its second-quarter results on July 18, with earnings of $1.26 per share, down 41% from last year's second quarter, and down from $1.63 per share in the first quarter. For the first six months of the year, Nucor has earned $2.88 per share, down about 11% from the first half of 2018.
In short, the steel market has changed drastically over the past year, and Nucor's results are indicative of that. Let's take a closer look at what Nucor reported, what's changed, and why, despite a clear weakening in several key metrics, Nucor's management is optimistic that the near term continues to look good for the company.
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The two things behind Nucor's weaker results
Without getting too deep into the details, steelmaking profits hinge largely on two things: volume of steel sold and steel pricing. Sure, basically every business's results are driven by pricing and volume, but for capital-intensive and high-fixed-cost industries like steelmaking, it doesn't take very much of a change in either metric to have an outsize impact on the bottom line. Here are some key Nucor metrics to demonstrate this:
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Revenue | $5,895.9 | $6,460.8 | (8.7%) |
| Net income | $386.5 | $683.2 | (43.4%) |
| Earnings per share | $1.26 | $2.14 | (41.1%) |
| Sales (tons) to outside customers | 6,724 | 7,197 | (6.6%) |
Revenue, net income, and sales (tons) in thousands. Source: Nucor Corporation.
As the table above shows, Nucor reported a 7% decline in steel volume it shipped to outside customers. What's not shown above is the second factor behind Nucor's 43% decline in net income and 41% drop in earnings per share: per-unit value. In Nucor's case, that's the price per ton the company can realize for the steel it sells, a metric that unfortunately fell 2% from last year's second quarter.
Combined, that's why Nucor's revenue fell almost 9%: It sold nearly 7% less steel, and for a 2% lower per-ton price. If we carry that over to Nucor's expenses, we will see why earnings fell sharply:
Nucor's biggest cost item is cost of products sold, which is a combination of the raw materials it makes steel out of, and the expenses directly tied to operating its steel facilities (including employee labor, energy costs, etc.), but it also has recurring corporate overhead and marketing expenses, taxes, interest expense, and other operating expenses it must pay. All combined, Nucor's costs and expenses were $5.48 billion in the second quarter versus $5.75 billion year over year.
Without putting too fine a point on it, steelmaking is very expensive, and with relatively thin margins. Steel prices and volume combined to fall at nearly double the rate Nucor's expenses and costs did; the result was a giant drop in profits.
Here's why management says the worst may be over
Back in March 2018, the Trump administration passed some of the most aggressive tariffs in decades on a wide swath of steel imports. The short-term result was a boost for U.S. steelmakers, particularly Nucor, which profited from a surge in steel prices and a decline in imported steel. The combination of higher prices and higher demand helped the company to its most profitable year in history, but as 2018 was winding down, management was already cautioning investors that steel prices were falling and demand in some end markets had weakened.
We saw this start playing out in the first quarter of 2019. Even though profits were up a strong 48% per share on much higher steel prices, Nucor reported a 4% decline in total steel shipments, setting the stage for what proved to be an even weaker second quarter.
In the release, CEO John Ferriola described Nucor's challenges in the first half of the year as being more seasonal in nature and temporary issues than a substantial downturn in the steel cycle:
Unusually wet weather and aggressive supply chain destocking impacted mill order rates in the first half of 2019. We have seen lower volumes during the first half of this year resulting in a more challenging price environment. However, real demand for our products remains strong in key end-use markets.
We see healthy conditions in end-use markets that typically account for more than two thirds of our steel shipments. For this reason, we are cautiously optimistic that pricing has bottomed for most products and that volumes should be more closely aligned with real end-use demand in the second half of the year.
Looking ahead
Nucor's outlook for the third quarter was still a bit conservative on how quickly things will improve. It expects to see improvements in the steel products segment as demand from key end markets remains strong, but both the raw materials and steel mills segments are expected to weaken further from the second quarter, pointing out that falling prices have only just started to reverse trajectory, meaning it will take more time before higher prices make an impact on the bottom line.
Put it all together, and it's looking like Nucor could sandwich a weaker second and third quarter with what was a strong Q1 and what could be a much-improved fourth quarter, so long as end-market demand remains strong and prices continue to rise. The company isn't likely to reach 2018's record profits in 2019, but it continues to deliver as the best, most-profitable steelmaker in North America.
