Is This Expensive Steel Company Worth Buying?

Amal is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Nucor (NYSE: NUE) is the largest steel producer in the U.S., and statistically it is the largest recycler of any material, recycling almost 1 ton of steel every two seconds. The company declared its 2Q 2013 results last month. Let’s take a look at how the largest steel manufacturer based on ‘mini-mills’ fared.

Quarterly performance

Nucor's revenue decreased 8.6% year-over-year to approximately $4.7 billion, but it beat consensus estimates of $4.5 billion. One of the reasons behind this drop was the weakness in sheet-metal demand, which caused a 1.4% year-over-year drop in shipments to outside customers and a 3.4% drop in total mill shipments.

Earnings missed consensus estimates by 10% and stood at $0.27 per share as compared to last year’s earnings of $0.35 per share, a decline of 23%. One of the factors that caused this was almost a 7% year-over-year decline in the average sales price per ton.

The scrap and scrap-substitute costs came down by 11.7% to $377 per ton as compared to $427 per ton a year ago, and this helped in maintaining earnings. This was primarily attributable to the better performance of the Trinidad DRI facility.

Nucor's board of directors declared a cash dividend of $0.36 per share in June. This was the company’s 161st consecutive quarterly cash dividend, and this is not a small achievement.

What next

It is expected that steel mills will see challenges in the residential construction sector as mortgage rates are now at their highest in the last two years. In contrast, the mood in the automobile industry is upbeat, and is bound to stay that way for a few years.

Nucor is also shifting to more value-added products, which offer better margins and should lead to higher revenue and profitability.

In November 2012, Nucor also entered into a long-term contract, lasting two decades, for natural-gas supplies for its steel mills and DRI plants. This will lead to energy-related cost savings, and hence contribute towards a reduction in the cost of production, which will have a positive impact on the bottom line.

Nucor's plans to grow are based on the improving efficiency of its existing operations and also the development of new technologies for steel production. In addition, it also plans to grow by strategic acquisitions that it feels will add value to its operations. Nucor acquired steel-foundation distributor Skyline Steel last June for $684 million as a part of its strategy. Revenue this year should start reflecting the results of this acquisition.

A look at others

It would be apt to mention a company that was formed by three ex-employees of Nucor. This company is Steel Dynamics (NASDAQ: STLD) and it was founded in 1993. Steel Dynamics has become the lowest-cost domestic-steel producer in the U.S. and is a perfect example of how businesses can compete based on the concept of providing identical products at lower costs.

Low-cost producers go on to become market leaders and Steel Dynamics is no exception. It has annual capacity of 6 million tons, producing a profitable mix of flat and long products. In fiscal 2012, Steel Dynamics notched a gross margin of 9.9%, compared to the 7.8% gross margin at Nucor.

There are two factors that weigh in favor of Steel Dynamics’ cost advantages. Steel Dynamics’ mini-mill model is much more labor and energy efficient. Secondly, Steel Dynamics’ facilities are strategically locatedcloser to both raw- material sources and the customers of its finished products, thereby reducing transportation costs significantly.

United States Steel (NYSE: X) is another competitor of Nucor. The company is the largest “integrated steel producer” in North America and its production capacity is much inline with that of Nucor. Last year, the company produced 19 million tons of steel.

U.S. Steel has had a tough year, and its shares are trading a tad above the 52- week low. One of the contributing factors towards the decline of the company is its huge pension obligations, as well as oversupply problems and volatile input costs. Also, the company is under a huge pile of debt amounting to $3.9 billion, which far exceeds its market cap of $2.7 billion.

The company trades at a cheap valuation, but its future is uncertain. Estimates for the next year range from a loss of $0.40 per share to a profit of $3.00 per share. So if you have a huge appetite for risk, look at this company; otherwise, it would be better to stay away.

Conclusion

For dividend investors, Nucor provides a healthy 3.1% yield. The company's stock has held on resiliently even in a weak market for steel and the fact that it pays a good dividend certainly works in its favor. Nucor has managed to stay profitable even in tough times and investors should stick to this stock. But the company trades at an expensive PE of 37, so there's no value for new investors as of now.

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Amal Singh has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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