2023-12-18 10:02:03 ET
Summary
- Nucor's stock has returned to a 52-week high, indicating increased optimism about a cyclical upturn in activity.
- The company released disappointing guidance for Q4 earnings, but the lower rate outlook and favorable secular backdrop make it a good investment.
- Factors such as lower interest rates, increased government support for infrastructure, and stabilization in the housing market will contribute to Nucor's growth in 2024.
In the past month, Nucor ( NUE ) has seen its stock return toward a 52-week high, and last Thursday, it rallied even after releasing guidance, which would seem disappointing. This speaks to the increased optimism about a cyclical upturn in activity, following more dovish Federal Reserve guidance. Shares are roughly flat since I reiterated my buy recommendation in September . With a lower rate outlook and favorable secular backdrop, I would continue to buy Nucor, even factoring in new guidance
On Thursday morning, December 14, the company guided to $2.75-$2.85 in earnings in Q4, below the consensus of $3.19 . This will be down from $4.57 last quarter due to weaker results across segments due to both lower prices and volumes. Nucor will release results on January 29, after the market close. For the full year, the company should earn about $17.60, based on results through September and this guidance.
Now, based on calendar 2023 earnings, the stock has a 9.5x P/E. However, based on its Q4 runrate, shares are just over 15x earnings. That is not particularly expensive, but it also does not appear as compelling of a valuation as a single-digit multiple. This creates the significant question of what 2024 will look like—will it be like all of 2023 or just the past few months.
While the future is inherently uncertain, there are several things we do know to help formulate a base case. First, during 2023, the Federal Reserve was raising interest rates; whereas, it now forecasts three rate cuts next year. Steel demand is closely tied to construction activity, generally speaking, more so nonresidential than residential as large infrastructure projects require far more steel than a single-family home. With interest rates coming down, the ability and willingness to do new construction projects should increase.
Alongside this I have argued in the past that Nucor should be a beneficiary of increased government support (via both direct spending and subsidies) towards infrastructure. Just this week, the Biden Administration made the first grant under the CHIPs Act. As this program ramps up further next year, it should support ongoing spending for semiconductor factories, facilities, which will need significant steel. This is on top of the bipartisan infrastructure spending bill, which is fully ramping up, and subsidies from the Inflation Reduction Act.
As you can see below, this combination has helped to meaningfully increase nonresidential construction over the past year, but the rate of growth slowed as rates continued to march higher. With more projects from these bills set to break ground over the next year, there should be support to maintain or increase the level of construction spending, while lower rates make private-sector construction more attractive
Because of rising rates over the past year, we have seen residential construction investment also decline. Builders, fearing lower demand, have pulled back on their activity, though we have seen some improvement from July. Again, residential housing is not a major driver of steel demand, but stabilization here will help. Higher levels of housing activity into the spring selling season can also lead to increased purchases of household durables, like appliance upgrades which can use some steel.
Another major user of steel is the auto sector, and auto sales have declined about 5% from May, running below pre-COVID levels. As a product that is generally financed by buyers rather than bought with cash, lower rates can help to bring buyers back to the market, especially with new car price inflation moderating (up just 1.3% year over year). The auto strikes also weighed on production and demand for steel last quarter, but with these resolved, we should see a steady-to-improving dynamic in 2024.
One sector of growth has been aerospace with production steadily rising as Boeing ( BA ) recovers from the pandemic as well as self-inflicted wounds. That company may be getting its mojo back, with a very strong showing at the Dubai airshow. While many of these orders are longer-dated, it provides a constructive backdrop for domestic steel demand.
I emphasize domestic steel demand, because Nucor is really a pure-play on US steel market dynamics, not global ones. Indeed with tariffs imposed by the Trump Administration and largely continued by the Biden Administration, the US steel producers are essentially insulated from international supply dynamics, which has helped to usher in this era of strong profitability amidst high demand.
Next year is a Presidential election year, and steel tariffs are among the few policies where both presumptive nominees agree. If anything, I anticipate rhetoric to revolve around building more products domestically, not rolling back tariffs. While this will not impact 2024 financial results, such rhetoric could support optimistic sentiment toward the steel producers. More importantly, I believe as investors begin to worry about winners/losers based on who wins the election, with candidates largely in agreement on this policy, Nucor’s outlook should remain positive irrespective of the outcome.
While normalized supply chains likely mean a return to peak steel margins is unlikely, the cyclical environment is beginning to get better for steel makers as lower rates begin to filter through the economy. Mortgage rates have now fallen below 7% after having reached 8%, which has yet to filter through to housing demand, for instance. On top of this cyclical swing, the secular tailwinds from increased government-supported infrastructure are still building and are likely to keep steel demand elevated for several years.
Nucor continues to be a strong way to play this trend. Its balance sheet is stellar with $5.9 billion of cash and equivalents against just $6.9 billion in debt. This will enable ongoing growth spending as well as capital returns. This year it has bought back about $1.4 billion in stock on top of its $388 million in dividend payments. That has reduced the share count by 4%. With $4 billion in year-to-date free cash flow, this has been fully funded with the company actually growing its cash balance this year.
While free cash flow will likely moderate somewhat in 2024, there is no need to continuing building cash, which should enable a similar pace of repurchases. I also expected the company to raise its dividend again, building on 49 years of dividend growth, and it announced that shortly after releasing guidance, implementing a 6% increase .
With activity in the process of bottoming and a 4-5% tailwind simply from a lower share count over the next year, I continue to look for shares to rise. I believe investors are right to look past the decline in Q4 earnings, as recent macro data points to an improving outlook for 2024. I continue to look for NUE to earn over $15 in 2024, which should be able to propel shares towards $200. With a multiyear construction cycle still in its infancy and a stellar balance sheet, Nucor is a great investment for long-term holders, in my view.
For further details see:
Nucor: Investors Should Look Past Weak Q4 Guidance