2023-03-21 06:15:00 ET
Summary
- Nucor's announcement of preliminary Q1 earnings took investors by surprise.
- Here I lay out how investors should think about steel's medium-term prospects.
- NUE isn't the cheapest of all steel stocks. But getting too caught up in its valuation isn't the key driver of this investment thesis.
Investment Thesis
Nucor ( NUE ) is priced around 10x 2023 depressed EPS estimates. But I don't believe that overly focusing on its valuation is the best way to understand this investment opportunity.
That's why I describe here the best way to think about NUE's steel prospects. And how NUE's strong balance sheet provides it with ample flexibility to return significant capital to shareholders.
Steel Prospects Are Stronger Than You May Think
In the past several days a few steel companies have preannounced their preliminary Q1 results. U.S. Steel ( X ) delivered a positive surprise, while both Nucor and Steel Dynamics ( STLD ) negatively surprised investors with their earnings.
Meanwhile, what surprised me most of all isn't so much that NUE negatively surprised investors with its preliminary Q1 result . But what I find most compelling to the NUE story is that steel prices remain stubbornly strong.
Indeed, it's not only that most other metals have seen their pricing fully compress in the past several weeks. But what's most interesting of all is that steel remains strong, even when we compare it to what some investors have termed "China's great reopening" narrative.
As a rough proxy for the "great China reopening" trade, consider copper prices. Copper is used to electrify China's real estate. With many investors comparing copper prices with investors' belief in China's reopening demand.
And as you can see above, since the end of January 2023, copper prices have not only stabilized but actually rescinded slightly from approximately $4.20 per pound.
Another rough proxy for China's reopening trade not delivering against expectations can be found in the malaise of WTI prices.
Moreover, even if steel's prospects are often commented as being tied to China's real estate market, my contention is that even if China's real estate market makes up 20% or 25% of global steel demand , there's a lot more to steel than just China's demand.
Consequently, this is my contention, demand for steel is less contingent on China than "superficial knowledge" would lead one to believe.
Steel is the foundation of our modernization. You can't build EVs without steel. You can't build solar panels and wind turbines, the backbone of our renewable energy requirements without steel. You can't build bridges and warehouses without steel. Steel is critical to our modern economy. It's the combination of tensile strength, durability, and cost-effectiveness.
Having discussed steel's demand, let's now shine a light on NUE's cost structure for 2023.
Massively Improved Cost Structure
Recall that to manufacture steel you require coking coal and natural gas. What's more, the US has access to some of the cheapest energy. Moreover, compared with 2022, 2023 will have substantially lower cost inputs.
Also, US companies will be able to undercut the overseas competition. Why? Because most other countries around the world, have energy input costs that are significantly higher than energy costs in the US.
NUE Stock -- Priced at 10x Earnings
On the face of it, analysts following NUE are expecting around $14 of EPS. That would put NUE priced at 10x this year's EPS.
But I strongly suggest that thinking about NUE simply from a P/E figure doesn't do this investment justice.
According to my own estimates, NUE will finish Q1 2023 with under $2 billion of net debt. That means that its balance sheet is in pristine condition and doesn't need massive amounts of free cash flows to improve its financial standing.
In actuality, as a point of reference, I believe that before NUE ends its Q1 2023 quarter, NUE will have returned to shareholders somewhere close to $460 million via share repurchases and dividends.
Some investors don't like to annualize this capital return, because share repurchases can be one-off events. But I still find it helpful to get some context. Thus, if one annualized this capital return it would amount to approximately 5.0% combined return. Something to think about.
The Bottom Line
NUE isn't the cheapest steel stock. But what it lacks in cheapness it makes up in quality.
In fact, as noted above, NUE's balance sheet is incredibly strong. That means after taking all the excess free cash flow it needs to grow its operations, NUE believes that it's able to return at least 40% of its earnings back to shareholders (see graphic above).
In conclusion, compared with other pockets of the market, I believe that NUE is a very attractive investment.
For further details see:
Nucor Preliminary Earnings: Understanding Steel Prospects