Reasons to Buy This Steel Product Manufacturer

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

Ever since the global economic slowdown, the metal industry has seen a lot of upward and downward movement. Since steel is an essential metal product, a commodity on which hundreds of metal products are based, it is advantageous to keep track of steel product manufacturing companies.

Last month, steel product manufacturer Nucor (NYSE: NUE) announced its 3Q12 FD EPS guidance of $0.30-$0.35 (vs. $0.46 in 2Q12 and $0.57 in 3Q11). I believe that lower 3Q12 performance attributes to a decline in operating performance at the company's steel mills, slowing economic growth and volatility in scrap prices. However, I believe that the company is attractively positioned to ramp up production and turn around underperforming business into even a gradually improving outlook for non-residential construction. Looking forward, I believe the company will drive good results due to following reasons.

 Balance Sheet Supports Further Growth

Management has updated that its net debt-to-cap rose to 26% in 2Q12 from 20% in 1Q12 largely due to the Skyline acquisition. Many are suggesting that NUE will take part in bidding on the ThyssenKrupp slab rolling facility in Alabama. However, I expect that the NUE wont acquire the Thyssen’s slab rolling facility as I believe if it were to acquire the facility it would contemplate eventually adding an electric arc furnace and slab caster near the site to make it vertically integrated. I anticipate further distressed opportunities after RG and Thyssen could be compelling to NUE. I believe NUE’s balance sheet provides ample opportunities for acquisitions which positioned the company well above its peers.

Strong Long Term Growth Prospects

Management has indicated that excess supply from domestic capacity and imports have been pressuring margins.  I believe that ABQ and plate were under pressure from imports, new capacity, and some recent equipment demand weakness(in 3Q). I believe longer term energy demand will absorb the additional capacity it and others were adding. Longer term I expect demand recovery in the U.S. to come from energy and other infrastructure and manufacturing growth.

Visibility Over DRI

I believe that the company specifically benefit from a higher price gas environment as it leads to increased manufacturing in response to cheap energy. Also, the company has plans to get the first DRI unit up and running before proceeding with a second, likely by 2015. Also the management has indicated that the technology and operations should be very similar to its Trinidad operations and easy to replicate. I believe that Nucor’s recent detailed cost economics for pig iron vs DRI seem overly conservative and I think its cost advantage is understated.

 Valuation is Justified on Absolute Basis

Nucor distinguishes itself from the rest of the steel industry with its use of scrap steel, a fact that makes Nucor the largest recycler in the nation. Nucor's main competitors are US Steel (NYSE: X) and Arcelor Mittal (NYSE: MT). The following table summarizes the Expected EPS growth, dividend yield and forward PE of NUE , US steel and Arcelor Mittal:

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Expected Annual Growth for next 5 years</p> </td> <td> <p>Dividend Yield</p> </td> <td> <p>Forward PE</p> </td> </tr> <tr> <td> <p>NUE</p> </td> <td> <p>8.8%</p> </td> <td> <p>3.7%</p> </td> <td> <p>12.08</p> </td> </tr> <tr> <td> <p>US Steel</p> </td> <td> <p>6.5%</p> </td> <td> <p>1%</p> </td> <td> <p>7.59</p> </td> </tr> <tr> <td> <p>Arcelor Mittal</p> </td> <td> <p>26.4%</p> </td> <td> <p>3.9%</p> </td> <td> <p>7.24</p> </td> </tr> </tbody> </table>

Arcelar mittal seems relatively cheap as its expected EPS growth is highest and is trading at lowest forward PE. Arcelor Mittal also offers impressive dividend yield which is also highest among its peers. I believe that Arcelor Mittal’s discounted valuation is not justified. Coming back to Nucor, I believe that the company valuation is appropriate on absolute basis as its dividend yield and expected EPS growth is impressive and it offers less exposure to  concerns over excess new sheet capacity compared with peers.

 I believe that the steel industry will continue to be challenging in 2012. However, I expect end market demand to be stable. I do not expect steel producers to hold material pricing power until 2013 at the earliest, at which time capacity utilization should increase to ~85% or higher. North American steel producers should report normalized earnings once again by 2013 as capacity utilization is right-sized back to the 80-85% level. however, the industry is likely to be volatile prior to this time. Therefore, I advise investors to buy on dips and sell on rallies.



sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool owns shares of ArcelorMittal. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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