Nucor (NUE) has increased its dividend for 44 consecutive years – every year since it first began paying dividends in 1973.
For a company operating in the cyclical steel market, this level of consistency is very impressive.
Nucor possesses a number of competitive advantages that have helped it navigate the many ups and downs the of the steel market, and the company could also be a large beneficiary of the Trump administration’s plans to limit steel imports.
Let’s take a closer look at this dividend aristocrat to see if it could be a high quality and timely investment idea for long-term dividend growth investors to consider.
Nucor manufactures steel products in the U.S. and Canada and began operating its first mini mill in the late 1960s. With production capacity that exceeds 27 million tons, Nucor is the largest manufacturer of steel products in North America.
Some of the main products Nucor manufacturers are carbon and alloy steel (used in bars, beams, sheets, and plates); steel piling; steel joists; steel deck; concrete reinforcing steel; cold finished steel; and steel fasteners. Steel is sold into a variety of end markets, but non-residential construction and automotive markets are the biggest drivers for Nucor.
Nucor reports its results in three segments: steel mills, steel products, and raw materials. Here are the company’s 2016 sales by product type: sheet (37%), bar (22%), downstream products (12%), raw materials (11%), structural (10%) and plate (8%).
Nucor is in a tough business. The price of steel is extremely volatile (see below), short-term demand trends are unpredictable, raw material costs can significantly fluctuate, and many overseas competitors are happy to irrationally flood the market with low-cost supply.
The chart below shows the price of hot-rolled band (HRB) steel over more than a decade across several different regions. It highlights the cyclicality of steel prices. The dark blue line shows prices in the U.S. which currently hovers around $680 per metric ton.
So, how has Nucor not only survived these challenges but also managed to raise its dividend with such consistency over the last 40+ years?
In a commodity business such as steel, it’s all about cost and financial discipline. Nucor runs an extremely lean business model that has made it one of the lowest-cost producers in the world.
Steel is generally manufactured in one of two ways. Traditional steel mills rely on iron ore, blast furnaces, and unionized labor.
Mini mills such as Nucor take a different approach, using recycled metal, steel scrap, and electricity to manufacture steel. These raw materials are usually cheaper than iron ore and require less labor and capital in their manufacturing process.
Scrap prices also tend to move with steel prices, providing a bit of a hedge throughout the steel cycle (e.g. if demand for steel falls, Nucor’s primary input cost will also likely fall in price, helping protect gross profit to an extent).
As a result, mini mills have more variable cost structures and production schedules that can be quickly adjusted up or down in response to market conditions.
Nucor also has a nonunion workforce that receives over 60% of its pay in the form of incentive bonuses, which further protects the company’s profits during periods of depressed demand.
The company is constantly looking for ways to expand its product portfolio to save costs and boost profitability as well. Nucor recently expanded its capabilities to produce advanced high-strength, low-alloy, and motor lamination steel products, for example. Nucor has also expanded its plate product portfolio with the acquisition of a specialty plate mill in Longview, Texas.
As a result, the company’s downstream steel usage has more than doubled from 8% in 2006 to 20% over the last decade, helping improve profits and reduce volatility along the way.
While the majority of steel manufacturers in the U.S. have transitioned to mini mills, one of the biggest players still uses blast furnaces – U.S. Steel. However, the company is now transitioning to use more mini mills, recognizing their relative effectiveness and superior profitability.
As seen below, U.S. Steel (X) and its blast furnaces burned through substantial cash during the financial crisis and was forced to cut its dividend.
On the other hand, Nucor’s low-cost, capital-light, labor union-free, and flexible mini mill model kept generating free cash flow throughout the entire period:
Nucor has diligently used its cash flow to increase shareholder returns and invest in profitable long-term growth.
Over the past eight years, Nucor has invested more than $7 billion in capital expenditures ($5 billion) and acquisitions (more than $2 billion), which have strengthened Nucor’s position as North America’s most vertically-integrated and diversified steelmaker, which reduces its dependence on any single end market and provides economies of scale.
Some of the prominent acquisitions include manufacturers of hollow structural section steel tubing, such as Independence Tube Corporation (October 2016) and Southland Tube (Q1 2017). It also bought Republic Conduit (Q1 2017), which manufactures steel electrical conduits.
These acquisitions have made Nucor the number two market leader in their respective segments, providing new growth avenues and expanding its value-added product offerings.
Nucor has consistently reduced its cost structure through vertical integration as well (it is the largest steel recycler in the country).
Nucor has primarily used recycled metal and steel scrap to manufacture steel, but it has increased its use of direct-reduced iron (DRI) as a raw material, building a large DRI plant in Louisiana in 2013.
DRI allows the company to create higher-quality products that are more profitable and less subject to import competition.
These products are typically required to meet certain specifications, often need just-in-time delivery, and have less margin of error (i.e. it would be costly for customers to return these products to China if they aren’t made right the first time).
Nucor’s continued productivity improvements and increased vertical integration have helped the company generate excellent cash flow over the past cycle compared to the early 2000’s:
Essentially, Nucor is the best house in a bad neighborhood and should remain well-managed as the company continues executing on its five key growth drivers (becoming a low-cost producer, attaining leadership positions in product lines, expanding higher-quality and higher-margin production, expanding and leveraging downstream channels to market, and achieving commercial excellence to complement its operational strength).
Steel is a commodity, and commodities are priced based on supply and demand. Companies that produce commodities are typically subjected to the market’s uncontrollable ups and downs unless they can somehow constrain supply.
Unfortunately the market for steel is global, and China is the biggest producer. According to World Steel, China produced about 50% of crude steel worldwide in 2016.
While Nucor has one of the lowest cost profiles in the U.S., there is little it can do to combat the Chinese producers that receive subsidies from China’s government and have lower labor costs.
Government subsidies allow them to dump steel in the U.S. at extremely competitive prices, so when the U.S. market is seeing strong demand for steel, it is a magnet for foreign imports, which account for about a quarter of the U.S. market.
The Wall Street Journal published an article in June 2015 that did a nice job covering the challenges faced by the two major remaining steel manufacturers in the U.S. (Nucor and U.S. Steel).
It noted that surging Chinese steel production had pushed steel prices down by 23% since January 2015, causing Nucor and U.S. Steel to ask the government for protective import tariffs on steel from China and four other countries.
As a result, the U.S. government imposed anti-dumping and countervailing duties (in some products) against some major steel exporting countries in 2016.
Still, many steel markets around the world are suffering from overcapacity (over 700 million metric tons of excess capacity, to be precise), causing steel products from low-cost countries such as China to flood the U.S. and pressure profitability. Companies like Nucor are crying for more import tariffs and greater government protection from illegally dumped imports.
While the Trump administration is certainly very interested in supporting the U.S. steel industry, the process to impose new steel imports has been a delayed so far. If the timing and magnitude of Washington’s potential actions are ineffective at addressing the problems Nucor faces, investors could be disappointed.
Beyond international supply concerns, the automotive industry is one of the two largest markets for steel in the United States. Though Nucor’s mid-single-digits percentage share of the automotive sheet steel market grants it sufficient room for growth, lighter-weight materials such as hard plastics and aluminum are increasingly posing as threats to steel (they help with fuel efficiency and can be cheaper to use).
Of course, near-term demand trends can also be volatile in major end markets such as energy. As you can hopefully tell by now, investing in the steel industry can be quite the rollercoaster ride and is not for the faint hearted.
Nucor’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.
Despite some of the drawbacks of the steel industry, Nucor’s dividend appears to be quite secure and has a nice Dividend Safety Score of 93.
Over the last four quarters, Nucor’s dividend has consumed 42% of its earnings and 57% of its free cash flow. As seen below, the company’s payout ratios have been volatile over the last decade but increased meaningfully from about 16% in 2005 to around 60% last fiscal year. Nucor grew its dividend faster than its earnings over this period.
For a cyclical company, its payout ratios are getting to be on the higher side of what I prefer, but it’s less of a concern with Nucor’s business model, which generates surprisingly reliable free cash flow in most environments.
As previously, Nucor is a cyclical business. You can see that the company’s sales and earnings fell more than 50% in fiscal year 2009 as global steel markets collapsed. They also rebounded strongly in 2010 and 2011, underscoring the violent swings the steel market can take.
Despite the swings in steel prices and demand, Nucor’s low-cost operating model and variable cost structure has enabled it to respond well to periods of low demand. As seen below, Nucor has generated free cash flow in eleven of its last 12 fiscal years.
Importantly, Nucor’s annual dividend payments total $1.51 per today. The company’s current dividend would be covered by the company’s free cash flow generation in each of the years during the financial crisis ($2.52 per share in 2009; $1.75 per share in 2010).
While industry conditions could always surprise to the downside, Nucor seems to be in good shape to keep paying its dividend under most worst-case scenarios for the steel industry.
Companies with strong competitive advantages typically earn high returns on their invested capital. We can see that Nucor enjoyed excellent returns from 2005 through 2008 when steel prices were higher and its customers were healthier. Since then, the market has mostly remained oversupplied and caused Nucor’s returns to fall to a more average level that suggests little moat.
Given the cyclicality of Nucor’s business model, paying attention to its balance sheet is really important. If steel markets drop again and credit markets tighten, Nucor could be forced to reduce its dividend to make principal and interest payments on its debt.
Fortunately, Nucor’s balance sheet looks alright. The company has about $1.6 billion in cash on hand compared to $4.4 billion in debt. The company could cover its entire debt with cash on hand and 1.5 years of earnings before interest and taxes (EBIT). Nucor is also the only North American steel producer to hold an investment-grade credit rating.
Nucor’s dividend looks reasonably secure, especially for a cyclical steel company. Its payout ratios have also become more reasonable compared to the past few years of depressed steel prices. Importantly, the company’s low-cost business model has helped it generate free cash flow in practically all macro environments, and its balance sheet is reasonably healthy.
Nucor’s Dividend Growth
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Nucor’s Dividend Growth Score of 44 suggests that the company’s long-term dividend growth potential is a little below average.
While the company has increased its dividend every year since it started paying dividends in 1973 (44 straight years), its dividend growth over the last five years has been very underwhelming.
As seen below, Nucor’s dividend has grown less than 1% per year during its last five fiscal years (note that the 10-year rate is due to special distributions paid before the financial crisis). For a dividend aristocrat, this is disappointing and reflects the challenging steel markets that Nucor has dealt with over this time period.
Nucor’s dividend growth prospects have improved over the last year thanks to higher steel prices. If higher prices persist thanks to new quotas and tariffs imposed by the Trump administration, helping fuel double-digit earnings growth over the next few years, Nucor’s payout should begin to grow at a healthy clip.
Over the very long-term, I wouldn’t expect the company’s dividend to grow more than 3% to 5% annually, which is also the growth rate Nucor’s earnings could experience over the long-term.
NUE’s dividend yield of 2.7% is lower than its five-year average dividend yield of 3.1%, but NUE also trades at a forward P/E ratio of 13.3, which is below the S&P 500’s 17.4 multiple and the basic materials sector’s 17.6 multiple.
Cyclical stocks like Nucor typically look cheap when their earnings are peaking and expensive when their earnings are nearing a trough. The stock has performed well following Trump’s election as investors started pricing in higher earnings in the coming years (NUE’s earnings are expected grow nearly 40% from 2017 through 2019).
The policy environment should remain favorable over the next few years with the current administration’s focus on supporting American industrial companies. The U.S. government has already enacted numerous duties and anti-dumping measures on steel imports, which have made U.S. steel prices higher than the global prices.
Nucor has also benefited from a recovery in steel prices with China curbing its excess steel capacity, as well as improving global demand.
Longer-term, however, it seems unlikely that Nucor will be able to grow its earnings by more than 3% to 5% per year. The steel market is too saturated and competitive, and Nucor is already the largest player in North America. Under those earnings growth assumptions, the stock’s total return potential appears to be about 6% to 9% per year (2.7% dividend yield plus 3% to 5% annual earnings growth).
It’s also very important to keep in mind that cyclical stocks are usually volatile. While Nucor’s long-term earnings growth might be 3-4% per year, growth will not be linear.
Earnings could fall 35% one year, double the next, and contract by 15% in the third year. The stock will whip around as well. For these reasons, I view most mature commodity stocks like NUE as “trading stocks” that do not fit as well with my buy-and-hold investment philosophy.
I would prefer to see a dividend yield well above 3% before getting more seriously interested in Nucor.
While Nucor’s dividend payment looks safe, the steel market is highly volatile and dependent on a number of exogenous factors.
There are many global competitors (e.g. China) with deep, government-subsidized pockets that can ship cheaper steel to the U.S. and pressure industry pricing, and it remains to be seen
While Nucor’s operations are very efficient and management is doing all of the right things, it ultimately has no control over the headwinds facing its business.
Though steel prices have rebounded in 2017, they may fall once again if Chinese demand declines or the Trump administration fails to effectively reduce steel imports in a timely manner, if at all.
Even though Nucor is a well-run company, the steel industry is not the best one to find candidates for long-term dividend growth investing.
Investors seeking more current income for retirement should consider reviewing some of the best high dividend stocks here instead.