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Near a 5-Year Low, Is This High-Yield Steel Giant a Buy?

By Reuben Gregg Brewer - Mar 14, 2020 at 10:15AM

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U.S. steel giant Nucor is built to survive a cyclical industry. Its stock price has fallen dramatically from its highs creating a potential bargain.

Nucor Corp. (NUE 5.29%) stock is currently trading at a five-year low. In fact, the shares are very near a 10-year low as well. At this point, they are down around 50% from the highs reached in early 2018. That's a painful decline, to be sure, but the bigger question now is whether or not the drop, which has the company's dividend yielding 4.7%, is opening up a buying opportunity for investors.

Ups and downs are the norm

The steel industry is highly cyclical, largely tracking along with the economy. That makes sense given that steel is an important product throughout the business world, from construction to manufacturing. However, this is a key factor to think about when investing in a company like Nucor. When times are good the stock price can reach extreme heights based on earnings that look impressively high -- but that just won't last. 

Man writing on notebook while standing in a steel mill

Image source: Getty Images

Indeed, as the economy cools, those earnings can quickly fall away along with demand. The stocks, as you might expect, tend to decline, often dramatically, during these periods.

And it looks like steel might be headed for one of the down periods based on the price action of domestic steel stocks like Nucor. The stock is nearly 50% below its 2018 high. That's close to the worst drawdown in the last 40 years. The only time it got smacked worse was the 2008-09 recession. That was one of the worst economic downturns in U.S. history -- yet Nucor only posted red ink in one year, 2009. Other than that year, it was profitable throughout that recession and afterward. That's a testament to Nucor's conservative culture, and why now is the time to start looking at this giant and well-run steel mill. 

Some more details

One of the most attractive things about Nucor right now is its roughly 4.7% dividend yield. That is near the highest levels since the last recession, and among the highest in the company's history. Using yield as a rough estimate for valuation, Nucor looks like it is in bargain territory today. But there's more: That yield is backed by an incredible 47 years worth of annual increases. Stop and think about that for two seconds -- Nucor operates in a highly cyclical industry, and has still managed to increase its dividend annually for nearly five decades. There has to be a good story behind that. 

For starters, the company is very conservative, fiscally speaking. Nucor's financial debt-to-equity ratio is almost always below that of its closest peers. Today, that metric comes in at roughly 0.25 times. Steel Dynamics (STLD 2.92%), which is run by former Nucor employees, is the next lowest in the peer group at 0.38 times. After that you have AK Steel (AKS), which is being bought by Cleveland-Cliffs in what is best viewed as a rescue deal, at 1.4 times, and iconic United States Steel (X 5.34%) at 1.9 times. Clearly, Nucor likes to maintain a very strong balance sheet.

NUE Financial Debt to Equity (Quarterly) Chart

NUE Financial Debt to Equity (Quarterly) data by YCharts

But there's more to appreciate about this steelmaker than just that. Nucor's operating and EBITDA margins have trended at the high end of the peer group over the last 20 years. It generally competes with Steel Dynamics for the lead -- not surprising, given that the management team at Steel Dynamics was essentially trained at Nucor. An important component of Nucor's impressive margin performance is its unique pay structure, which uses a base pay level that is augmented by a profit-sharing component. When times get tough, its employees share in the pain and Nucor's costs are reigned in. (In good times employees generally earn above-market rates, which Nucor is happy to pay because it is doing well, too.) 

Another key factor here is the company's intense focus on being an industry leader. That includes investing capital even when times are tough so that Nucor exits downturns in better shape than it enters them. In fact, right now Nucor has a huge building program in the works that will require roughly $2 billion in spending in 2020 alone. However, with a strong balance sheet, it should have little problem getting through all of its plans. And, more important, each investment sets the company up for better long-term performance. In typical Nucor fashion, some of the projects are meant to give it logistic and price advantages over peers in commodity-type steel sectors, while others extend its reach into higher-margin specialty products. It can be hard to watch Nucor spend during a downturn, but history suggests it will be well worth the effort.

Add it all up and Nucor is easily one of the best-run steel mills in the United States, if not the world.

Start looking now

To be fair, there could be more downside risk in Nucor's stock price in the short term. But there's no way to time the bottom, so it's better for long-term investors to recognize that this domestic steel giant looks cheap and enticing right now. If you can handle owning an industry leader in a cyclical sector, you should strongly consider jumping aboard Nucor today. If you are worried about the price falling further, consider making several smaller investments over time to build a full position.

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Stocks Mentioned

Nucor Corporation Stock Quote
Nucor Corporation
$126.31 (5.29%) $6.34
Steel Dynamics, Inc. Stock Quote
Steel Dynamics, Inc.
$78.13 (2.92%) $2.22
AK Steel Holding Corporation Stock Quote
AK Steel Holding Corporation
United States Steel Corporation Stock Quote
United States Steel Corporation
$25.06 (5.34%) $1.27

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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