Why Nucor has been able to protect its profitability
Which factors determine Nucor’s profitability?
Profitability for steel companies like Nucor Corporation (NUE), ArcelorMittal (MT), U.S. Steel Corporation (X), and Reliance Steel & Aluminum (RS), is largely a function of the raw material costs and the final selling prices of steel products. The industry profitability movements have resembled a pendulum in recent years. There have been huge swings in profits reported by steel companies. Nucor is also exposed to volatility of steel scrap and finished steel prices.
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Volatility in steel prices
Steel prices have been quite volatile as can be seen in the previous graph. The final selling prices are a function of multiple factors like global prices, demand for steel, and overcapacity in the industry. This volatility is also resembled in the stock prices of steel companies.
How Nucor has protected itself from this volatility
While it’s beyond any individual company to control either the raw material or the steel prices, through long-term contracts it can bring predictability. Nucor has had a raw material surcharge mechanism in place since 2004. Nucor has basically two sets of customers for steel mill products. While one set of customers buys at the spot price, with the other set there are variable terms. Under these terms, which are generally non-callable in nature, the prices are fixed depending on prices of scrap and other raw materials. As of beginning 2014, ~45% of steel mill customers for Nucor had this contract pricing.
During strong steel market conditions, this surcharge is an effective mechanism to pass the increased raw material costs to customers. However, during subdued market conditions and cheap import threats, intense competition reduces the pricing flexibility to a great extent. Contract pricing has reduced the earnings volatility for Nucor.
Along with the steel companies listed above, investors can also look at the SPDR S&P Metals and Mining ETF (XME) to get exposure to the steel industry.