Leading North American steelmaker Nucor (NUE -1.74%) provided third-quarter earnings guidance for investors just two weeks before the end of the reporting period. So when the company announced it missed the lower end of the range by $0.02 per diluted share with net earnings of $7.28, some investors reacted quickly by selling the stock.
Even with only a slight miss, it seems many thought the peak of the cycle has passed. But those that studied the company's the earnings call heard a subtle comment by the CFO implying that the reason for the miss can really be considered a good thing for the cyclical business.
Selling the cycle peak
Some investors include cyclical stocks in a portion of a portfolio, with a plan to follow a sort of playbook hoping to time the cycles. That playbook is somewhat counterintuitive in that it calls for selling the stocks when the price-to-earnings ratio is at the lowest point. Most people think of a low P/E as a signal to buy stocks. But for cyclical stocks like Nucor that typically rely on commodity prices to maximize earnings, investors think of the P/E bottom as the sign that the cycle, and earnings power, has peaked.
That thought process explains why Nucor stock dropped more than 5% intraday when it reported record third-quarter earnings on Oct. 21. The single quarter's profit in fact almost matched the company's previous annual record net income set in 2018. And management said it expects the fourth quarter to potentially break a quarterly record. If it even matches the recent results, the stock would be trading at a P/E of just 4.5 based on 2021 earnings.
Reading between the lines
But what sellers of the stock may have missed is what management said in more detail in the conference call with analysts. It may be true that as far as steel pricing goes, the top has arrived. Steel prices have tripled over the past 12 months, but have drifted off recent highs.
And the CEO of peer steelmaker Steel Dynamics, Mark Millett -- who is also chairman of the Steel Manufacturers Association industry trade group -- recently agreed that steel prices should "erode" by early next year, as supply chain constraints ease and additional capacity ramps up. Millett added that based on current inventory and import conditions, "it would be natural to see pricing turn over."
Those pandemic-related supply chain issues, in addition to the timing of planned outages, are what Nucor said contributed to its earnings miss. CEO Leon Topalian bluntly stated in the earnings call, "Let me be clear. We did miss our guidance because of shipments." In other words, it wasn't demand-related, but rather impacted by moving finished product to customers. In a key related comment, CFO Jim Frias implied that the issues may help extend the current cycle:
"Logistical challenges throughout the economy continue to represent a risk factor. However, the moderating influence this is having on current demand may prolong the duration of this favorable economic cycle."
What shareholders want to hear
So while pricing may be peaking, management seems to believe the business itself may be in more of a plateau than at a top. That makes sense for several reasons. The company shares that 70% of its sheet business is done on contract terms. So it has visibility with that portion of its sales. And even if steel pricing eases, it would still be well above 2019 levels, resulting in continued strong cash flow and profitability.
Putting it all together, investors that sold on the earnings miss thinking we are at peak cycle might be missing out on a continued time period of near-peak earnings and cash flow. Nucor aims to return 40% of net income to shareholders, so those that held will continue to participate in the business success.