With a majority of metals producers having a very difficult 2013 so far, it is becoming tougher to find bright spots in the sector. However, the minimill-steel producers have actually performed well, with sector-leader Nucor Corporation (NYSE:NUE) very close to its 52-week high. Why are shares of Nucor and other minimill steelmakers not as beaten down as some other steel plays, such as United States Steel Corporation (NYSE:X) ? Also, would investors be better off looking into one of the poorly performing companies?
What is a minimill?
Before we get into Nucor Corporation (NYSE:NUE) itself, let’s do a quick rundown of minimills and steel production. A minimill is a steel production method where an electric arc furnace is used to melt scrap steel recycled from various sources, such as automobiles. Other steel makers use blast furnaces used by integrated steel mills to turn raw materials into liquid iron for steel production.
About Nucor
Not only is Nucor Corporation (NYSE:NUE) the largest minimill steelmaker in the U.S., it is the largest overall steel producer in the country as well. Nucor is also the largest recycler in North America of any material, with almost 20 million tons of steel produced annually from recycled steel. The company produces steel products for a variety of uses, including beams, steel joists, concrete reinforcing steel, fasteners, framing, and wiring to name a few.
Nucor Corporation (NYSE:NUE) plans to grow through increasing efficiency in its existing operations and developing new technologies for steel production, as well as by strategic acquisitions that it feels will add value to its operations. Most recently, Nucor acquired steel-foundation distributor Skyline Steel last June for $684 million, and 2013’s revenue should begin to reflect the benefits of this.
A little expensive, isn’t it?
At first glance, Nucor Corporation (NYSE:NUE) appears to be a bit on the pricey side at about 31.5 times trailing-12 month earnings. The steel industry’s profitability is expected to begin to rebound over the next several years, and this should lead to better profit margins and therefore higher earnings. As a result, the company is expecting to earn about $1.72 per share this year, which is expected to rise to $3.60 and $4.41 in 2014 and 2015, respectively. So, although it looks very expensive, Nucor trades for just 12.2 times next year’s projected earnings.
While this looks excellent, bear in mind that the rebound of the steel industry is far from certain. Earnings estimates for this year range from $1.23 to $2.39, which implies that the 20 analysts who follow the company don’t really have a firm picture of what’s going on with the company. Further out, the estimates get even less precise, with 2015’s earnings projections varying between $3.15 and $5.39, a huge discrepancy.
The point is that although the general trend is agreed to be upward, the magnitude of the upward trend depends on several things that are still up in the air, such as the amount of consolidation in the industry in the coming years, raw materials costs, and increased pricing pressure from competitors (especially overseas).
Minimill competition: Commercial Metals
Commercial Metals Company (NYSE:CMC) is another purely minimill-based steel company, and is a fraction of the size of Nucor Corporation (NYSE:NUE). Commercial Metals Company (NYSE:CMC) trades for 20 times this year’s earnings, and is expected to grow similarly to Nucor over the next few years, but just like Nucor, Commercial Metal’s (NYSE:CMC) earnings growth is far from certain. The consensus calls for $1.78 per share in 2015, but estimates range all the way from $1.35 to $2.15. It is tough to make valuation interpretations in an industry whose future is based on an anticipated turnaround, but using a similar figure as I used for Nucor Corporation (NYSE:NUE), Commercial Metals Company (NYSE:CMC) trades for 10.7 times next year’s expected earnings. So, on the surface Commercial Metals Company (NYSE:CMC) looks a little cheaper, but Nucor has the strength that comes with being an industry leader, which is certainly worth a bit of a premium.
U.S. Steel: cheap, but for a reason
U.S. Steel has certainly had a tough year, and shares are just above their 52-week low. The company is the largest integrated steel producer in North America and its output is actually very close to Nucor Corporation (NYSE:NUE)’s at about 19 million tons last year. U.S. Steel’s decline is due not only to oversupply problems and volatile raw materials costs, but also the company’s enormous pension obligations. Additionally, the company carries a very high level of debt ($3.9 billion), which is actually more than its market cap of $2.5 billion.
As a result of this, U.S. Steel trades at a “cheap” valuation, but the company’s future is even more uncertain than its minimill competitors. Estimates for next year, for example, range from a loss of $0.40 per share to a profit of $3.00 per share. If the most optimistic analysts are correct, that means that U.S. Steel trades for just 5.8 times next year’s earnings, but that’s a big “if”.
The last word
For those with an appetite for risk, these steel companies could provide tremendous gains if the industry turns itself around as expected. Signs of a turnaround would include increased production, higher steel prices, and increased M&A activity in the sector. Of the three mentioned, Nucor is perhaps the least risky and the most appropriate for a long-term investment.
Matthew Frankel owns shares of United States Steel Corporation (NYSE:X). The Motley Fool recommends Nucor Corporation (NYSE:NUE).
The article What Is the Best Way to Play a Steel Turnaround? originally appeared on Fool.com.
Matthew is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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