Friday, October 24, 2014

Nucor Q3 Earnings: Strong Results in a Tough Environment


Steel-intensive, nonresidential construction projects like this one remain near historic lows. Source: Nucor.

Another quarter, another strong performance by steelmaker extraordinaire Nucor  (NYSE: NUE  ) . Revenue for the quarter came in at $5.7 billion, 8% above last year's quarter and well above the market's expectation of $5.37 billion. Earnings also came in strong, with EPS of $0.76 coming in above both Nucor's guidance and analyst estimates.

However, there are still a number of headwinds in the steel industry, so despite the improved results even Nucor has a lot of work ahead of it. Let's take a deeper look at the earnings release. 

Operational improvements and product mix behind profit growth

Steelmakers have high fixed costs than can be tough to lower in periods of declining demand. Because of these high costs, even a small reduction in output can have an outsize impact on earnings and cash flow. Nucor has long been an industry leader at managing its fixed costs and responding to the market environment. 

DRI produced in Louisiana. Source: Nucor.

Much of this profit growth can be summed up in one key metric: utilization rates.

So far this year, the company's utilization rate is significantly improved compared to last year, increasing from 74% in 2013 to 78% so far in 2014. This is one big driver of improved profits in 2014 versus last year. 

The company also pointed to improved profitability in its fabricated construction products business versus the second quarter of this year, due to improvements in the nonresidential construction market. While total revenues increased 15% over last year, total tons shipped increased only 10%, meaning that Nucor was able to command higher prices. This was driven both by higher-price products and by some cost increases it was able to pass along. 

Headwinds remain 

While Nucor has been able to raise its prices modestly, imports continue to put pricing pressure on the steel market. However, the tariffs implemented earlier this year do seem to be having some impact on improving conditions for domestic steelmakers. 

However, tariffs won't do anything to improve the demand picture. While there has been strength in supplying manufacturing goods for the automotive market and the energy industry, the building industry -- both residential and especially nonresidential -- remain at historically low levels of production. Until the demand cycle turns, Nucor and the rest of the industry will continue competing for a smaller pie. 

Looking forward 

Nucor completed its acquisition of Gallatin Steel in the quarter, which will expand its capacity of flat-rolled steel -- used for pipe and tube steel -- by about 10%, and in the Midwest, where demand is the highest. This facility will be able to use direct-reduced iron from Nucor's Louisiana DRI plant, a further benefit of this facility and its scale. 

Nucor continues doing what it does best: making smart acquisitions that fit within its operational strategy, investing in growth, and keeping its costs low, while positioning the company to remain profitable in bad markets as well as good ones.

It's tough to say when the steel demand cycle will fully rebound. However, Nucor will clearly be ready when it happens. Until then, it remains the most operationally sound steelmaker in the industry, and its management team keeps investing in growth and stability -- a hard thing to do in a tough industry. 

If you're looking for a consistent dividend, Nucor and its 3% yield will be steady. However, I wouldn't count on any significant payment increases before the steel market recovers.

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