Adding a Steel Name to the Bullpen

With the first 100 days of the Trump administration coming to a close, we continue to scour the markets for opportunities in companies and sectors that can benefit further from policies yet to come and macro trends still developing. Today, we are adding Nucor (NUE) , the U.S. steel producer, to the bullpen with the intention to add the position to the portfolio in the coming days. 

The steel industry has been a focus of investors since the election as President Trump's expected infrastructure spending policies are likely to infuse growth for the country's major operators. From a high level, Trump's insistence on anti-dumping policies will be a tailwind for the entire industry. As Nucor stated in its most recent quarterly press release, "Imports continue to impact the U.S. steel industry. ... The U.S. International Trade Commission has also voted unanimously that the domestic industry is being injured by dumped and subsidized plate imports from China, Brazil, Turkey and South Africa." China is the largest national producer of steel, and because it makes more than its country can consume, the excess is often sold overseas (into the U.S., for instance) for pennies on the dollar, thereby undercutting domestic producers. The Trump administration is looking to end this process and help support the U.S. industry moving forward. 

In fact, Trump launched a trade probe last week against China and other exporters of cheap steel into the U.S. market, using Section 232 of the Trade Expansion Act of 1962, which affords the president the right to impose restrictions on imports for reasons of national security. According to a Reuters article, Trump has said, "Steel is critical to both our economy and our military. ...This is not an area where we can afford to become dependent on foreign countries." Powerful words in support of the U.S. steel industry. 

Chinese steel accounts for roughly 25% of the U.S. market, meaning there will be a big hole to fill should the investigation halt imports or at least impose some sort of restrictions or tariffs on foreign steel. Responding to a question on Nucor's recent earnings call regarding the Section 232 investigation, Nucor CEO John Ferriola noted, "We welcome an investigation into the impact of imported steel upon our national security, particularly given that many of these steels are imported illegally, violating our trade laws. ...You asked about, in particular, how does this really impact national security? And when you talk about steel, clearly, steel plays a major role in national security. Case in point, look at the armored plate grades that we've been developing at Nucor. I mean, submarine applications, tank applications. There's numerous applications for steel in military use, and it is critical to our national security." 

Regardless of whether foreign dumping of steel does in fact pose a risk to national security (according to Reuters, the Defense Department's annual steel requirements comprise less than 0.3% of the industry's output by weight), from a pure investment perspective, the mere focus of the administration on supporting U.S. steel creates opportunities for investors looking to choose stocks within the industry. 

This brings us specifically to Nucor, which is the largest steel producer in the United States, primarily serving commercial, municipal construction and industrial markets. The company operates in three major segments: steel mills, steel products and raw materials. Nucor is also the largest metals recycler in North America. The steel mills segment produces and distributes a range of products including sheet steel, plate steel, structural steel and bar steel. The steel products division manufactures a range of products including steel joists and joist girders, steel deck, fabricated concrete reinforcing steel, cold finished steel, steel fasteners, metal building systems and wire/wire mesh. The raw materials group processes and brokers ferrous and non-ferrous metals as well as producing direct-reduced iron and natural gas. 

Those who watch Mad Money may be familiar with Nucor as Jim most recently hosted Ferriola for an "Executive Decision" segment back in March. With the new administration's focus on U.S.-based steel for construction of pipelines, we view Nucor as one of the best plays on the trend. While there are certainly other U.S. steelmakers that can benefit from the president's favoring of U.S.-based manufacturing, we believe Nucor offers the best growth and most diversification for stability. See below for a look at the company's diversified product mix (Source: Nucor 2016 annual report): 

Importantly, Nucor has a history of growing throughout steel cycles, investing during the downturns in order to emerge more profitable and diversified for the future. The business is able to do this thanks to its best-in-class balance sheet and industry-leading return on invested capital, highlighting management's ability to recognize the most effective and profitable ways to utilize the company's capital. NUE has remained steadily active on the acquisition and partnership front, finding areas of opportunity in sectors such as oil and gas and automotive as well as in downstream products. You can see a chart of NUE's major acquisitions below (Source: Jeffries). 

Even with a laser focus on growth, management still finds a way to keep shareholders happy in the short term, providing a solid 2.5% dividend yield that is backed by the company's underappreciated free cash flow generation capabilities. Nucor has roughly $1.7 billion in cash available, not to mention its $1.5 billion revolver (does not expire until 2021), which can be used for funding. Management noted that dividend growth will be commensurate with earnings growth, a bullish signal for investors seeking income given that the company is expected to accelerate earnings in the coming quarters, thanks to both an improving macro backdrop and the success of internal initiatives. 

While management has acknowledged that the dividend may have been raised too prematurely in past cycles, earnings growth moving forward continues to support at least marginal dividend boosts in the future and certainly a backing of the current payout. In addition, the company has had the tendency in the past to provide special dividends to shareholders during periods of growth. CFO James D. Frias perhaps hinted about this on the recent earnings call, when he responded to a question on shareholder allocation with: "So let's see how the rest of 2017 plays out, and we'll think more about whether it's appropriate to increase the dividend or do something with other dividends or do other things to return cash to shareholders by the end of the year." 

The company reported earnings for the first quarter last week that were within the guidance range, but importantly, management suggested sequential acceleration moving forward. As such, the company's profitability could "significantly exceed the level achieved for 2016." We believe the company has a solid path toward achieving that goal as it executes on its five drivers for profitable growth. 

1: Strengthen the position as a low-cost producer. 

2: Achieve market leadership positions in every product line within the portfolio. 

3: Move up the value chain by expanding capabilities to produce higher-quality, higher-margin products. 

4: Expand and leverage downstream channels to market to increase its steel mills' baseload volume for sustained results. 

5: Achieve commercial excellence to complement the company's traditional operational strength. 

Overall, we believe the macro backdrop for the U.S. steel industry and Nucor's consistency offer investors a way to play an attractive market under the new administration while also providing company-specific growth levers that can support share price gains moving forward regardless of the political landscape. A tight U.S. market, with the potential for import restrictions, supports continued pricing strength and strengthening equity valuations in the space.

Action Alerts PLUS, which Cramer co-manages as a charitable trust, has no positions in the stocks mentioned.