Why Nucor trades at premium valuations to other steel companies
Premium valuations for Nucor
Nucor trades at a premium to its peers. You can look at any metric like the price to earnings ratio (or PE) or enterprise value (or EV) to earnings before interest, taxes, depreciation, amortization (or EBITDA) to support this fact. We analyze Nucor and its peers based on EV to EBITDA because this is a better ratio to use in a cyclical industry like steel.
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Historical premium enjoyed by Nucor
The valuation difference between Nucor and other U.S. steel companies has been a historical phenomenon. This is evident in the previous chart which shows the trend in EV to EBITDA for Nucor compared to its peers. The rich valuations of Nucor don’t reflect that the stock is expensive. It’s actually a result of operational superiority and the faith investors have in the company. Similarly, lower relative valuation doesn’t simply reflect the cheapness of a stock, but should be analyzed holistically.
Why Nucor commands a premium
So far, we have seen various factors that suggest that Nucor is better placed compared to its peers. There are certain factors that make Nucor enjoy a valuation premium.
- Low financial leverage – We have seen how Nucor has low debt ratios compared to its peers. Lower debt reduces the riskiness of a stock by reducing the fixed obligations in the form of interest payments. It helps a company post better profits.
- Low operating leverage – Since Nucor primarily uses an electric arc furnace (or EAF) for steel making, it shields the company from high fixed costs in downturns. This helps the company protect its profitability even in downturns.
- Consistent record of profitability – While other steel makers like ArcelorMittal (MT) and U.S. Steel Corporation (X), have been struggling with losses, Nucor (NUE) has had a consistent track record of posting above average profitability. Along with Nucor, Reliance Steel & Aluminum (RS) also enjoys high profitability. Nucor also has a generous dividend policy. We’ll analyze the dividend policy and its importance for investors in the next section.
An investor can also choose exchange-traded funds (or ETFs) to invest in instead of picking individual securities. The SPDR S&P Metals and Mining ETF (XME) is one ETF that invests in U.S. based steel companies.