Companies with strong competitive advantages typically earn high returns on their invested capital. We can see that NUE 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 NUE’s returns to fall to a more reasonable level that suggests an average moat.
Source: Simply Safe Dividends
Given the cyclicality of NUE’s business model, paying attention to its balance sheet is realty important. If steel markets drop even further and credit markets tighten, NUE could be forced to reduce its dividend to make principal and interest payments on its debt.
NUE’s balance sheet looks alright. The company has about $2 billion in cash on hand compared to $4.4 billion in debt. Even with earnings looking depressed, the company could cover its entire debt with cash on hand and two years of earnings before interest and taxes (EBIT). Morningstar has also given NUE an “A-” credit rating.
Source: Simply Safe Dividends
NUE’s dividend looks reasonably secure, especially for a cyclical steel company. Its payout ratios don’t provide as much flexibility as other companies, but these figures are currently being calculated during a time of extremely 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.
Dividend Growth Score
Our 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.
NUE’s dividend Growth Score of 7 suggests that the company’s dividend growth potential is very weak. While the company has increased its dividend every year since it started paying dividends in 1973 (43 straight years), its dividend growth over the last five years has been very underwhelming.
As seen below, NUE’s dividend has grown less than 1% per year during its last five fiscal years. For a dividend aristocrat, this is disappointing and reflects the challenging steel markets that NUE has dealt with over this time period.
Source: Simply Safe Dividends
Going forward, we expect NUE’s dividend growth to remain very low until steel markets recover (assuming they eventually do). Thereafter, we still wouldn’t expect dividend growth to exceed 3-5% per year, which is also the growth rate we expect the company’s earnings could experience longer term.
Valuation
NUE trades at about 16x forward earnings and has a dividend yield of 4.3%, which is meaningfully higher than its five year average dividend yield of 3.2%. Cyclical stocks like NUE typically look cheap when their earnings are peaking and expensive when their earnings are nearing a trough (investors are pricing in higher earnings in the coming years).
With steel prices near their 2008-09 low, investors are hopeful that macro conditions are about as bad as they can get for NUE. If they are right and steel prices rally sharply by 30%, the stock will likely do quite well.
Longer-term, however, it seems unlikely that NUE will grow its earnings by more than 3-4% per year. The steel market is too saturated and competitive, and NUE is already the largest player in North America. Under those earnings growth assumptions, the stock’s total return potential appears to be about 7-9% per year.
It’s very important to keep in mind that cyclical stocks are usually volatile. While NUE’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, we view most mature commodity stocks like NUE as “trading stocks” that do not fit as well with our buy-and-hold investment philosophy.
Conclusion
Nucor Corporation (NYSE:NUE) has the fifth highest yield (4.3%) of all the dividend aristocrats. While the dividend payment looks reasonably safe, the steel market has become increasingly challenged. There are numerous global competitors (e.g. China) with deep, government-subsidized pockets that can ship cheaper steel to the U.S. and pressure industry pricing. While NUE’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.
Steel prices do appear unusually depressed at the moment and could unexpectedly rebound to drive the stock higher in the near term, but that is not the game we try to play with our dividend growth investing. We will stick with some of our favorite blue chip dividend stocks instead.
Disclosure: None
