Nucor reported its first-quarter earnings today which were better than expected. While the earnings were slightly below the guidance, the guidance lost relevance as it was issued before the surge in US coronavirus cases and shutdown orders. While the US steel industry has been designated an essential service, steelmakers are curtailing capacity amid tepid demand. U.S. Steel Corporation has especially been hard hit amid the fall in US steel prices.
After the great financial crisis, the US steel industry has faced several other challenges. China’s steel demand growth rates started to come off while it kept on churning record tons of steel every year. This resulted in a steel import crisis in the United States. US steel imports eventually peaked in 2015. However, concerns over China’s slowdown coupled with a fall in energy prices triggered a sell-off in metal prices in 2015 and 2016. US hot roll coil prices plunged below $400 per ton in the first quarter of 2016 which was even lower than their lows in the 2008-2009 crisis.
In 2018 and 2019, the US-China trade war and concerns over the global slowdown drove US steel prices lower. US steel industry faced a crisis in 2019 despite a 25% tariff on imports that President Trump imposed in the preceding year. This year, the COVID-19 pandemic has halted the nascent recovery in the US steel industry. The pandemic is the biggest economic challenge of our times with the impact far exceeding the great financial crisis.
While peers like U.S. Steel had to curtail plants several times since 2015, Nucor has been sitting pretty. It has been gradually increasing its dividends and also investing in new plants including higher margin value add products. Nucor has low operating and financial leverage than its peers. Let’s discuss this in perspective.
Nucor produces steel in electric arc furnaces that have a lower fixed cost structure. The company primarily uses steel scrap as the raw material. US steel prices tend to follow scrap prices. This gives Nucor a natural hedge as its key raw material and finished steel product prices are interwound. This is unlike blast furnaces like those operated by U.S. Steel. Not only do they have a higher fixed cost structure, but they also use iron ore as the main feed where prices don’t move alongside US steel prices. U.S. Steel mines its own iron ore in the US.
Looking at Nucor’s operating model, it keeps its base salaries below median but offers a variable component that is generally higher than peers. This means that its salary bill drops in crisis situations. Also, the company has low financial leverage as compared to some of its peers. A sound balance sheet gives Nucor the optionality to pursue organic growth, acquisitions, as well as enhance shareholder returns.
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