Nucor: Steeling The Show (NYSE:NUE)

Shares of Nucor (NYSE:NUE) have seen quite some volatility in 2022, but on a net basis it has been rather positive. In May of this year I wondered if too much confidence was seen in the case of Nucor, as the business saw huge earnings momentum.

That in itself is not a sign of overconfidence of course, yet management (which has been preparing for such a situation), announced to buy back shares and announced a big deal, raising some questions behind the (diversifying) capital allocation strategy. Nonetheless, I concluded to remain confident with Nucor in the long run, adding to a long position in May.

Some Perspective

Nucor is an interesting steel producer, one which is certainly subject to economic cycles, yet at the same time has been able to outperform its peers in the long haul, driven by a focus on cost-effective operations and conservative capital allocation strategies. An $80 stock in 2008 was based on a $25 billion business which posted peak margins of 15% at the time. In the meantime, the company has been gradually upgraded its facilities, with capital spending considerably exceeding deprecation charges.

2008 was of a strong year ahead of the recession looming as the decade which followed was essentially a lost decade. After all, 2019 sales came in at just $23 billion, which marks a small decline in sales in nominal terms, certainly if we factor in a decade long period of inflation. Operating earnings fell from $3 billion to $2 billion, translating into low double-digit margins, with earnings coming in around $4 per share, as shares were down to $50 per share.

During the pandemic year 2020 sales fell to $20 billion, yet the recovery started soon in 2021 in a hugely convincing manner. First quarter sales rose to $7.0 billion amidst a recovery in volumes and pricing, to grow to $8.8 billion in the second quarter, with earnings power moving up even in a more pronounced manner. This made that shares rose to the $100 mark in the summer of 2021, for good reasons as earnings power trended around $20 per share at the time. Third quarter sales rose to $10.3 billion, to end the year with a $10.4 billion quarterly sales contribution and earnings trending above $30 per share on an annual basis.

After an initial move lower at the start of this year, shares rose to a high of $190 per share as the war between Russia and Ukraine broke out, resulting in an explosion in steel prices, as shares were back to $120 in May of this year. At that level I concluded to be a buyer even as signs of a top were clearly visible with the company guiding for first quarter earnings of around $7.25 per share, as earnings did eventually come in at $7.67 per share on $10.5 billion in sales.

The 272 million shares valued the company at $35 billion, that is we factor in a modest net debt load. Amidst this valuation and the situation, Nucor announced a rather unexpected $3.0 billion deal for KKR-owned C.H.I. Overhead Doors at a 13 time EBITDA multiple, all while the own business traded at just 3 times. This left the question if buybacks had been more opportune, but of course current earnings power is not indicative here going forward.

While I had some questions on capital allocation skills in the spring, I am impressed with the long term capital allocation skills, making me an avid holder of the shares. For that reason, I actively added at $120 per share again following some profits taken earlier in the spring.

Volatile Action

Since my upbeat tone in May shares initially fell to nearly the $100 mark in June to show some volatility during the summer, now trading at $150 per share again, marking solid 25% gains in a time frame of about half a year.

Shares recovered by mid-June as the company guided for strong second quarter earnings, expecting earnings to come in around $8.80 per share, aided by strong operating conditions and continued and rather aggressive share buybacks. This resulted in debt inching up, certainly as the C.H.I. acquisition closed by the end of June.

In July, Nucor posted second quarter earnings equal to $9.67 per share on $11.8 billion in sales, far ahead of the guidance, with earnings now trending at close to $40 per share! These trends were clearly not sustainable as volumes were actually down year-over-year and while the company expected another solid third quarter, earnings were set to come down.

Promising is that net debt came in at $4.3 billion by the end of the quarter, down quite a bit from the pro forma $5.0 billion number upon the C.H.I. acquisition announcement as net earnings came in at $2.6 billion in the second quarter.

Coming Down

In September, it became evident that earnings have reached their peak as the company guided for third quarter earnings to come in at a midpoint of $6.35 per share, down year-over-year, and down more than three dollars from second quarter earnings power. This did not withhold the company from aggressively buying shares, having bought more than 5 million during the quarter at an average price of just $122 per share, allocating more than $600 million in capital to this end here.

After announcing some new facilities and related investments in these, the company announced third quarter earnings of $6.50 per share in October. Lower earnings came as volumes fell 10% year-over-year as revenues fell to $10.5 billion on which earnings of $1.7 billion were announced. Net debt came down further to $3.3 billion, despite lower earnings and continued capital allocation, as working capital efficiency was impressive.

This net debt load is minimal despite continued aggressive buybacks, the C.H.I. deal and some organic net capital expenditures. Troublesome is that the company guided for further weakness in the fourth quarter, as the company cites more challenging market conditions and economic uncertainty.

The question is how far earnings will fall, but it seems as if quarterly earnings power likely falls below $5 per share, reading between the lines, but the range of expected earnings could be quite wide. Nonetheless, it is comforting to see Nucor remaining very profitable, having used the very strong second and third quarter earnings to further deleverage the balance sheet and buy back shares.

With annual earnings power reported at $40 per share in the second quarter, this might already have come down to just $20 now, as a 50% reduction in earnings still results in a mere 7-8 times earnings multiple if earnings come in around $5 per share in the fourth quarter. In the meantime, balance sheet integrity has been preserved, as the company announced a diversifying acquisition to provide more diversification during downturns, while continued capital investments into the business were made to make sure the business remains up to speed on that angle.

Given all this, I remain a happy holder here, although I recognize the downside risks as well, making me inclined to perhaps sell a part of my stake on rips from the $150 mark higher here.