Nucor (NYSE: NUE) manufactures and sells steel products. The infrastructure spending bill is expected to lead to 4 million to 6 million tons of additional steel demand. Thus, you are having very high steel demand.
At the same time, the price of steel is close to a 5-year high and looks set to climb higher.
Furthermore, many of Nucor’s peers based in Europe or Russia are now being removed from the market for different reasons, but nevertheless, being put out of the competition.
Meanwhile, Nucor’s balance sheet is very strong as of right now, with approximately $ 2.5 billion of net debt, which is less than 0.4x of net debt to EBITDA.
Altogether, here’s why I believe that paying approximately 7x this year’s free cash flows for this business is compelling.
Investor Sentiment Picks Up For NUE Stock
If you follow this space you know the overall narrative already. Steel production has fallen because of a myriad of factors. And the companies that are extremely well-positioned to benefit from this are in the US
One of the biggest input costs to make steel is natural gas. With natural gas prices low in the US relative to many parts of Europe, US manufacturers have a dramatic advantage in being able to underprice the competition.
What’s more, there’s no reason to realistically expect near-term demand for steel to decrease. Finally, bringing new supplies online could take at least another 2-3 years. The perfect storm for US-based steel companies, combined with low valuations.
Nucor’s Revenue Growth Rates Will Remain Strong, Near-Term
Nucor had a very strong 2021, thus any comparison against the prior year is likely to look less impressive this time around.
However, you do not need triple-digit growth rates for this business to be attractive. You just need another few quarters of these positive dynamics coming together for investors will be meaningfully rewarded here.
Why Nucor? Why Now?
Nucor manufacturers steel and steel products, including bars, sheets, and steel piling, to name a few.
In essence, its end markets are mostly in construction and ” heavy industry ”. Accordingly, these end markets have a lot of pent-up demand, particularly given President Biden’s infrastructure bill.
What’s more, as you know, the biggest manufacturing exporter of steel is China. And China has signaled its intent to cap its production of steel, in an effort to curb carbon emissions.
Then, you add to that this dynamic Russian sanctions, and you end up in a situation where you have a lot of demand, combined with supply shortages.
Consequently, even though prices for steel are slightly lower than in the same time year ago, the overall trend here is clear, steel prices are close to a 5-year high. And not likely to stop increasing soon.
Also, keep in mind that a ceasefire in Ukraine does not mean that sanctions will be removed any time soon.
And not to state the obvious, but steel production is not like software where you can just write up some code and deploy it globally.
To this extent, President Biden has just this week has sought to remove steel tariffs from UK imports. But what we are talking about here is a mere drop in the ocean. It’s a headline grabber that does very little to meaningfully alleviate supply constraints.
Here’s the backdrop, the deal will allow 500K metric tons of British steel to be imported duty-free into the US. This compares against approximately 26-28 million tons of imports the US makes in a year.
Therefore, the indication appears to point to Nucor’s profitability to remain elevated for a good few years.
Nucor Free Cash Flow
Nucor has approximately $ 2.5 billion of net debt. For a business that made approximately $ 4.6 billion of free cash flow, this is a very strong fiscal position.
Moving on, Nucor expects to achieve a new record for first-quarter earnings of $ 7.25 at the midpoint. Compared with the same period a year ago this is a jump of 134% y / y.
To give you some context into just how strong Nucor’s near-term prospects are, since the start of the year, Nucor has returned to shareholders $ 630 million in the form of share repurchases and dividends. This implies that in less than 90 days, shareholders got 1.5% return on capital. And that does not include any share appreciation, which is still very much still in play.
Looking ahead to 2022, assuming the current pricing environment, together with the company’s guiding for increases in capex to approximately $ 2.3 billion, we are likely to see approximately $ 5.5 billion of free cash flow this year, an approximate 20% jump compared to last year.
NUE Stock Valuation – Cheap
If we take my estimate for free cash flow, the stock is priced at approximately 7x this year’s free cash flow.
However, obviously, this multiple is based off this year’s free cash flows, which my guess is as good as yours. In fact, nobody knows exactly how steel prices will unfold throughout 2022.
What we do know is that right now in Europe, with natural gas and electricity prices soaring, it quickly becomes uneconomical to produce steel. Further, you have China wanting to cap production, Russian sanctions, and Europeans finding it challenging to produce steel. The lasting impact of all these different macro aspects is totally unforeseeable.
That being said, I’m inclined to believe that this opportunity is compelling.
The Bottom Line
As always when investing in commodities, there are so many different known unknowns and unknown unknowns. How much steel will China import from the world? How long do sanctions against Russia stay in place? Will the price of gas in Europe fall to make it more economically viable to manufacture steel?
All these estimates have dramatic implications. On the other hand, from what we can see very near-term, the outlook here is probably the best it’s ever been for Nucor. Although, how long it lasts is anyone’s guess.
In sum, I’m very much bullish on this space, but I’m invested in a smaller peer, where I believe its upside is even more compelling. Whatever you decide, good luck and happy investing.