Nucor: Attractive Amidst M&A And A Favorable Long-Term Outlook (NYSE:NUE) (2024)

Shares of Nucor (NYSE:NUE) have been a solid performer over the past year, rising about 26%, but shares have been falling over the past two months, amid mixed guidance. On Monday June 3^rd, Nucor announced another acquisition as it gradually diversifies its business, and I view such efforts positively. I last covered Nucor in December, reiterating it as a “buy.” However while the stock did briefly reach my $200 target, performance since that reiteration has been disappointing, with NUE down 4% while the market has rallied by 11%. I would use weakness to add.

In the company’s first quarter, Nucor earned $3.46, up $0.30 sequentially but down by $0.79 from a year ago. On a blended basis, steel prices per ton rose by 1% sequentially but were down 3% from last year. Nucor generated $1.5 billion of EBITDA and did $1 billion of Q1 buybacks, leaving it with $2.3 billion of buyback authority. Returning capital to shareholders is a critical part of the Nucor investment thesis with management aiming to return at least 40% of earnings per year. In Q1, it returned over 130%. Management noted the buyback was “higher than normal” given its elevated cash position, which is still $5.5 billion. Thanks to repurchases, its share count is down about 4% over the past year.

We have seen Nucor continue to deploy capital, not just to shareholders, but to pursue growth organically and inorganically. On this front, it acquired Southwest Data Products, which focuses on data center infrastructure for $115 million on April 1^st. Data centers have specific niche infrastructure needs given the need to maintain cool temperatures, and NUE is creating a stand-alone group to focus on this. With AI driving a need for even more computing power this should be a source of ongoing demand growth. Moreover, increased electricity usage may necessity more demand from utilities as they expand grid capacity. This is a very small purchase—just about 0.25% of the Nucor’s enterprise value—so it will have limited financial impact.

Additionally on Monday June 3^rd, Nucor announced it is paying $565 million to acquire Rytec, representing 12.5x 2024 estimated EBITDA. It specializes in making commercial doors, like rigid rolling doors for warehouses and manufacturing facilities. This is a natural expansion to the company’s overhead door unit. Back in 2022, Nucor spent $3 billion to buy CHI Overhead Doors, which was a 13.0x multiple.

Given the higher interest rate environment, a lower multiple than in 2022 makes sense. Still, it is at a premium to Nucor’s own valuation. NUE trades at a 7.8x EV/EBITDA multiple, by comparison. However, Nucor’s business is blend of commodity steel and steel products, which are higher margin, so this value-add unit should be valued at a higher multiple. NUE should also be able to find revenue and cost synergies with its existing CHI operations and use its wider array of door offerings to sell to its existing manufacturing and construction clients. This will diversify about 1% of Nucor’s earnings away from steel. While Nucor is gradually broadening its manufactured offerings, given the sheer size of its steel business, these actions are inevitably merely incremental.

I view these diversification efforts positively; given the tremendous cash flow Nucor has enjoyed since 2020 thanks to the very favorable steel pricing environment, it makes sense to deploy some cash to broaden the business on top of shareholder returns and organic growth efforts. Over time, they should help to somewhat reduce the volatility of NUE earnings, which can lead to a higher multiple. Additionally, with NUE able to fund purchases out of cash rather than by increasing borrowings, it is easier to find accretive purchases. In the short term though, steel market dynamics will drive the stock. Concerns about H1 steel market activity have been a key source of weakness, but I think some concerns are overstated.

Q1 earnings were a bit messy, even as they remained elevated on an absolute basis. EPS missed by $0.16, but this was due to the fact the loss at its Corporate/eliminations entity was $398 million from $271 million last year, an over $0.30 incremental headwind. Some of this was due to higher medical insurance costs, a real expense. Most was timing. As I will discuss further below, Nucor is engaged in a large cap-ex program. Steel mills are built, to a large extent, out of steel. Because of its size, it supplies a lot of steel to its own projects. However, a company cannot book a profit on an internal sale, as one entity’s profit is another entity’s expense, resulting in an eliminating accounting entry.

Nucor supplied more of its own steel to its cap-ex projects than it expected in the quarter, resulting in this larger elimination drag. Now, a building requires a fixed amount of steel, but the cadence of construction can determine the exact timing of deliveries. As such, what we should see over the balance of the year is less steel going to its own projects and instead being sold externally, resulting in a normalization in this eliminations loss. Based on management commentary, I expect more of this benefit to be felt in H2 than Q2 (though there will be some Q2 improvement), but timing nuances like this I do not view as particularly meaningful. I would rather Nucor build its projects in the most cost-efficient way rather than worry about quarterly accounting noise to generate the best long-term returns for shareholders.

Aside from this, operating results were reasonably strong. Steel mill (its commodity unit) profits of $1.1 billion were up from $838 million a year ago and $588 million in Q4. Mill shipments rose by 7% from last quarter and per ton margins rose to $187 from $107 thanks to higher prices and moderating input costs. Q1 steel mill pricing of $1,108/ton rose from $1,015 in Q4 and $1,084 across calendar 2023. This continues to be a healthy pricing environment, thanks to solid end-market demand, aided by government stimulus, which I will discuss further below. Additionally, steel tariffs enacted by the Trump Administration and continued by the Biden Administration continue to restrict global supply and support prices. Given both Presidents have followed this same policy, I see little risk to these tariffs from the election and view them as a quasi-permanent part of US industrial policy.

While steel mill profits were extremely strong, Nucor’s value-add segment showed some moderation. Steel products profits fell to $512 million from $971 million last year and $656 million in Q4. Steel products margins compressed to $512 per ton from $656 in Q4 with volumes down 5% amid weaker pricing in metal buildings and rebar fabrication. Steel product pricing of $2,608/ton was down from $2,776 in Q4 and $2,845 over all of 2023. Even as this unit showed some weakness, it is also clear why NUE is moving more into products via M&A. Unit margins are 3x as higher per ton with a selling price that is more than double. By continuing to add product offerings, overall Nucor margins should see a tailwind.

Given strong earnings, Nucor continues to be a highly cash generative business. In Q1, there were over $750 million in working capital headwinds, and Nucor generated about $540 million in free cash flow adjusting for this. It spent $670 million of cap-ex, and I expect this spending to rise through the year as the company plans to invest $3.5 billion in cap-ex this year, with about two-thirds going to growth projects. This is part of a $7.1 billion multiyear capital program, led by a West Virginia sheet mill plant set to open in 2026 for $3.5 billion. The WV plant spend this year is about $1.2 billion.

Now, in the near-term, management expects earnings to decline sequentially in Q2 due to weaker pricing. However, management has also reiterated it expects 2024 to be “strong” but not a record year. It sees end-markets “flat, stable, or slightly improving.” While management is historically conservative and has not been prepared to call Q2 the bottom, it does anticipate a second half acceleration.

Given the stock’s negative performance over the past two months, I believe the market is pricing in weakness persisting due to concerns over still-elevated interest rates reducing the construction spending environment, thereby weakening steel demand. I see less reason for concern and do expect Nucor’s earnings to stay resilient. As you can see below, nonresidential construction drives the majority of the company’s business, followed by energy, machinery, and auto. It is critical to emphasize Nucor is tied to nonresidential not residential construction. Factories, utility networks, and bridges use lots of steel; single-family homes do not.

This makes Nucor’s end demand much less interest rate sensitivity than if it was tied to housing. This is especially the case because I believe we are seeing a secular force driving nonresidential construction: government stimulus. Nucor expects 5-8 million tons of incremental steel demand over each of the next four to five years due to the CHIPS Act, Inflation Reduction Act, and Bipartisan Infrastructure bill, which I view as reasonable. These programs have already been appropriated funding and begun allocating funds. Still, most projects are just beginning with the CHIPS Act further along than the others. There has also been some “delay” in infrastructure spending vs Nucor’s expectations.

Ultimately, this should just be timing, as these funds have been allocated, reducing the sensitivity of spending to broader economic conditions. Supply-side capacity limitations may also be playing a role in the slower roll out. As you can see below, nonresidential construction spending has boomed, aided by government stimulus, and boosting Nucor profits. The level of spending though has stalled out, holding at an elevated level but not rising further.

My view is that with government spending persisting over several years, given the multiyear nature of the legislation, we are likely to see construction activity stay around current levels but likely not rise further. This should help support Nucor maintaining its current level of profitability for some time. With government spending still rolling out, I do expect pricing blips, like we are seeing in Q2, to be transitory, and for the steel upcycle to persist for several years.

Additionally, Nucor has a pristine balance sheet with $5.5 billion in cash and just $6.8 billion in debt or about 1x EBITDA. Even with ~$700 million of deals announced and another $2.8 billion in capital spending for this year, Nucor should have room for further buybacks as it should generate at least $3.5 billion of operating cash flow over the rest of the year. With its dividend costing another ~$400 million, I would expect another ~$1.1 billion of buybacks to bring cash down to about $4 billion at year-end.

I expect Nucor to generate at least $2 billion in free cash flow and at least $13 in EPS. At less than 13x earnings and with a 5% free cash flow yield, I view shares as attractive, especially as cap-ex needs should fall in 2025-2026. As these new projects come online and go from needing cap-ex to generating profits, free cash flow should accelerate meaningfully higher and I view $3-3.5 billion in run-rate free cash flow and over $16 in EPS by 2026 as reasonable, meaning we should continue to see buybacks, tuck-in M&A, and dividend increases.

I still view $200 as a fair target price, or about 15x mid-cycle earnings, given my view we are seeing a multiyear demand cycle for steel, and aided by Nucor’s excellent balance sheet. That points to over 15% upside, and positive commentary about H2 could help reverse current negative sentiment. In my view, investors should look past one or two quarters of noise and focus on the long-term value Nucor is creating for shareholders, using dips as opportunities to add to positions. I still view shares as a buy.

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