We maintain our Neutral recommendation on Nucor Corporation (NUE - Free Report) , the largest producer of structural steel, steel bars, steel joists, steel deck and cold finished bars in the U.S.
Recently, Nucor reported a year-over-year profit growth of more than 220% to $0.94 per share for the second quarter of 2011, which also beat the Zacks Consensus Estimate of $0.81. Results were driven by increased demand and prices for steel mill products. We believe NUE’s strong cash flows and balance sheet will provide flexibility to continue its growth strategy.
Nucor expects third-quarter results to outpace the second quarter, despite some market weakness that may impact results toward the end of the period. Furthermore, the company continues to see slow but steady improvement in demand from certain end-markets.
Long-term contracts, cost reduction efforts and a dominant acquisition strategy could benefit the company in the coming quarters, but the massive industry over-capacity continues to weigh on steel prices. As such, there is a bleak overall near-term price outlook.
Nucor’s utilization rates have improved tremendously since the fourth quarter of 2010 and are expected to improve further in the coming quarters. As the company returns to profitability, the recent price increases for all steel mill products are expected to have a positive impact on earnings. We believe end-markets are experiencing some real demand improvement that will continue throughout 2011.
The average utilization rates of all operating facilities in the steel mills, steel products and raw materials segments were approximately 75%, 55% and 74%, respectively, in the first half of 2011 compared with 72%, 52% and 72%, respectively, in the first half of 2010. The average utilization rates, in the steel mills segment in 2011, were negatively impacted by downtime caused by severe weather-related events and resulting power outages that occurred during the second quarter.
However, Nucor suffers from inflated raw material costs. Lower production rates at the mills have slowed the rate at which they consume the higher cost iron units, particularly pig iron inventories. However, pig iron consumption had increased midway through 2009.
Nucor is facing higher scrap and scrap substitute prices. Scrap and scrap substitutes are the most significant elements in the total cost of steel production. Nucor believes it will continue to experience volatile raw material costs during 2011, as the end-markets are experiencing some real demand improvement that is expected to continue throughout 2011.
Steel competes with other materials, such as aluminum, cement, composites, glass, plastic and wood. Increased use of these materials as substitutes for steel products could have a material adverse impact on prices and demand for Nucor’s steel products.
In 2011, automobile producers must begin complying with new Corporate Average Fuel Economy ("CAFE") mileage requirements for new cars and light trucks that they produce. As automobile producers work to produce vehicles in compliance with these new standards, they may reduce the amount of steel in cars and trucks to improve fuel economy, thereby reducing demand for steel and resulting in further over-supply of steel in North America.
Nucor faces stiff competition from Commercial Metals Co. (CMC - Free Report) and United States Steel Corp. (X - Free Report) .