Nucor (NYSE:NUE), one of the largest steel companies in North America, has three priorities when it comes to using its cash flow: investing in the business, increasing its dividend, and buying back stock. Right now, Nucor has big spending plans, with over $3.5 billion worth of projects either in the works or on the drawing board. In 2020 alone it will spend $2 billion of that. Here's what Nucor is doing with all that cash, and what it means for investors.
It's going to get tight
Fiscally speaking, Nucor is a very conservative company. Relative to its closest peers it stands out for its financial strength. To put some numbers on that, its financial debt to EBITDA ratio of roughly 1.6 times is lower than that of any of its U.S. competitors, and its ability to cover interest expenses by 16 times is stronger than any company in that group. Further, the company ended 2019 with $1.8 billion worth of cash and short-term investments, and had a completely untapped line of credit worth $1.5 billion.
There's no question that Nucor has the cash it needs to spend heavily on capital projects. That said, with plans to spend roughly $2 billion in 2020 alone, there's going to be a lot of money going out the door over the next year or so. In fact, during Nucor's fourth-quarter 2019 conference call, CFO James Frias addressed this fact head-on, explaining: "And so, we're going to have peak capex over the next two years and then it should taper off based on the projects we've announced and have in our pipeline actively today. And so, we could be slightly cash flow negative over the next two years."
That cash flow shortfall will have to be made up somewhere, with the balance sheet the most likely location. Simply put, Nucor's leverage is likely to increase over the next year or two as it builds out its list of projects. It has ample financial strength, so this isn't the end of the world, but it is something that investors need to know going in and watch closely as construction efforts progress. Making the issue a little less worrisome, however, is the fact that the expected cash flow shortfall includes the dividend payment -- so the cash flow shortfall won't be quite as bad as it at first sounds.
That said, Frias was clear what the end goal of all of this spending is: "[B]ut over the next five years, we would expect to be strong cash flow positive." In typical Nucor fashion, it is spending on things that it expects to lead to revenue and earnings growth. Notably, however, the steel industry isn't exactly in a great state today, with some peers actually shutting assets down. To get a handle on what Nucor is planning, here's a list of some of its biggest projects and the logic behind each of them.
Where the money is going
Nucor breaks its investments down into a few categories. The first is investments with logistical advantages. That list includes two reinforcement bar (or "rebar") mills, one in Florida and the other in the Chicago area, for a total cost of $425 million. Rebar, which is used in construction, is a commodity product that is largely bought based on cost. The location of these mills is the key, as they will be near high-demand markets that are currently underserved. Thus, rebar has to be shipped in from other regions. Putting mills closer to the markets will give Nucor a logistical cost advantage over peers.
The next big investment bucket is moving up the value chain. While Nucor makes commodity steel (like rebar), it prefers to produce higher-value items for which it can charge premium prices. To that end, it is putting $180 million toward a joint venture in Mexico that will serve auto manufacturers in that country. Steel for cars is increasingly complex as automakers look to reduce weight while still retaining the structural integrity of their vehicles. Mexico, meanwhile, is an important location; lower labor costs have led vehicle production to shift into that nation to meet demand in the United States.
The three projects above are expected to come on-line by the end of 2020.
However, there's a lot more than that in the works. In 2021 Nucor is expecting two value chain enhancing projects to come on-line worth roughly $925 million. One expands the company's Gallatin plant, allowing it to produce wider and thicker steel gauges. This will permit the company to sell into new markets that it couldn't serve before. The second big project for 2021 is a new galvanizing line in an existing Arkansas facility that will let Nucor to serve regional customers with a premium product that it couldn't offer before in the area.
The last big project in the works won't be completed until late 2022 and falls into the final project bucket, a mix of logistical advantage and moving up the value chain. Nucor is spending $1.35 billion -- easily the largest investment here -- to build a new mill in Kentucky to produce steel plate products. There are two things going on with this mill. For starters, it will be a state-of-the-art facility capable of producing a broad range of high-value end products. Secondly, it will be situated close to low-cost transportation and within a region that has high demand for the products it will produce. Of all of the investments here, this one is likely to be the most important to watch based on its size.
Worth the risk
Although the cyclical U.S. steel industry is working through a weak spot right now, Nucor is still planning to spend heavily over the next couple of years. That's going to result in tighter-than-usual finances for a bit, but it has very specific reasons and expectations for each of its projects. In fact, this type of countercyclical investment is pretty typical of the company, which likes to use downturns to strengthen itself for the future. If history is any guide, it is making the right move despite the expected short-term impact on its cash flow and balance sheet.
Dividend investors willing to keep a close eye on their investments might want to take a closer look at Nucor, noting that its 3.3% yield is compelling today and backed by 47 years of consecutive dividend increases. You don't achieve that kind of record by making poor choices with shareholders' cash. So while Wall Street focuses on the big pipeline of investments today, long-term investors should remember that Nucor has successfully used this playbook many times before.