An Update on a Best-of-Breed Steel Producer: Nucor (NUE)

6 Oct 2021 3:00 PM EDT

Shares of Nucor, a stock we recently initiated during its sell-off, are trading even lower today after analysts at Goldman Sachs downgraded their rating on the shares to neutral from buy with a $108 price target following the stock’s outperformance versus its peer group. The analysts also upgraded their rating on Cleveland-Cliffs to buy despite Nucor being the best-of-breed company in the industry with the superior balance sheet and the most environmentally friendly production.

Best of breed explained:

Before we get into the downgrade, let’s first talk about the topic of what makes a company best of breed. This designation can mean a lot of different things. Best-of-breed companies are industry leaders or market share gainers. They have bankable management teams with long track records of success. They are forward thinkers. Their products and services that are in constant reinvention. They have favorable shareholder policies.

We understand how the analysts are trying to get ahead of what they think will be a correction in steel prices, however, we see several reasons why prices could remain resilient. Instead of focusing too heavily on what could go wrong with the price of steel, let’s take a look at what can go right on the demand side and cause prices to remain higher for longer.

The auto industry is a huge end market for Nucor. Even though all the major automakers are going through production delays due to the chip shortage, demand for new cars remains strong and we should see steel consumption pick up once the automakers secure the chips. What happens to the demand for steel after the chip shortage eases hopefully in 2022 and auto production rates greatly increase to meet the demand?

How about energy? Demand for steel in this industry has been weak, but with WTI crude firmly above $70 per barrel, we could see the need for more steel tubes and fittings in oil and gas rigs, as well as more pipelines. In renewables, offshore wind farms require a huge amount of steel to be produced. And we would not sell Nucor ahead of the potential passing of a comprehensive infrastructure package which should boost demand over the next several years.

Lastly, let’s not forget about the capital return story here. Management is committed to returning at least 40% of earnings back to shareholders. Nucor is currently delivering record levels of profitability, and that cash is coming back to shareholders through a huge share repurchase program. Even Goldman Sachs pointed out that Nucor screens most attractive on a capital returns yield (dividend yield plus share repurchase yield) relative to peers.

Bottom Line: Can Nucor trade back down to the upper $80s again, which is where we added to our position back in July? Of course. The market is very volatile right now. However, we believe Nucor is doing everything right and the industry tailwinds that lay ahead make us think this downgrade call is short-sighted, especially with the stock already down about 25% from its high. We would buy shares again if it fell back to that level because Nucor is a best-of-breed company that we won’t trade around.