The U.S. government is debating an infrastructure spending bill, and domestic steelmakers are likely to benefit. Indeed, the big question isn't whether or not there should be a bill, but how big it will be. Steel is integral to infrastructure. With that backdrop, you might be wondering if you should consider buying Nucor (NUE 0.22%), the largest U.S. steelmaker. Here's some things to think about before you make the final call.
Big and diversified
Nucor has a $30 billion market capitalization, which is more than twice the size of the next-largest domestic competitor. The company lays claim to being the largest and most diversified mill in North America, with 27 million tons of capacity across 25 mills. It has the No. 1 or No. 2 position in 11 industry segments. Notably, around 20% of its volume comes from its steel products groups, which take internally generated steel and create higher value products to sell, increasing the company's margin along the way.
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The company's size, diversification, and scale have resulted in very consistent performance over time. Although there are many ways to look at this, one of the best is probably the company's 48 consecutive years of annual dividend increases. Nucor is a Dividend Aristocrat (at least 25 years of annual increases), and just two years away from becoming a Dividend King (at least 50 years of annual increases). You don't create a record like that without doing something right, as steel is a highly cyclical industry that tends to rise and fall along with the economy.
One key piece of the company's long-term success is its use of electric arc scrap furnaces, which tend to be more flexible than blast furnaces that make primary steel. Both are needed, since you can't have scrap steel without first creating primary steel. But the smaller electric mills are, to put it simply, easier to ramp up and down with demand. Another important piece of the puzzle is that Nucor's employees receive profit sharing that is tied to performance. So in good years they benefit along with the company, but in return they share in the pain during bad years. That helps reduce Nucor's costs exactly when it needs extra flexibility.
Although Nucor is hardly perfect, it is likely one of the best-run steel mills in the world. And with the prospects of an infrastructure spending boom, there's reason to believe the near-term future will be pretty robust. While all this background is important, and a good reason to consider adding the stock to your portfolio, it isn't enough to make Nucor a buy.
Timing counts
As noted above, Nucor is a cyclical stock. Not only does its business rise and fall along with the economy, but so too does its stock price. So investors need to be particularly careful that they don't buy it during periods of exuberance, because it will likely just fall back down to earth when expectations dim in the future. Indeed, the time to buy Nucor is when investors are downbeat on the company's prospects.
That time is not now. But some numbers might help to clarify the situation. The company's dividend is a really great guide, given that the quarterly payment has never been cut. The yield today is roughly 1.6%, which is a touch higher than the 1.3% you would get from an S&P 500 index fund. However, Nucor's yield is near the low end of the company's historical yield range, and the absolute lowest the yield has been over the past decade. Using yield as a valuation gauge, this suggests that investors are pricing in a lot of good news right now.
The stock's price action bears that out. The shares are up 140% over the past year. Granted, that time span includes the 2020 coronavirus-related bear market, but the S&P 500 index was only up around 40% in the same period. That's a huge amount of outperformance for a company that makes steel. Much of that gain, meanwhile, has come just since the start of 2021, with Nucor's stock up over 90% through the end of May compared to a 12% gain for the S&P 500.
The current administration's infrastructure spending plans are a big piece of the outperformance here. But in the end, it's pretty clear that investors are upbeat about Nucor's prospects -- which is exactly when investors should be most worried about buying Nucor's stock.
Hold tight
Nucor is a great company, which its size and history of success points out. However, because it's a cyclical steelmaker, long-term investors need to be careful about when they choose to step in. Nucor's stock appears highly prized by Wall Street today and, as such, most investors will likely be better off waiting. If history is any guide, Nucor will eventually fall out of favor again and the stock will become cheap. It is worth putting this giant steel mill on your watch list, but it probably shouldn't be on your buy list right now.
