Nucor’s profit margins
As we observed earlier in this series, steel companies are finding it tough to manage their profit margins amid falling steel prices and lower capacity utilization rates. As of the week ending August 26, 2015, the capacity utilization ratio in the US steel industry was almost ten percentage points lower than what it was during the same period last year.
Electric arc furnaces
Nucor Corporation (NUE) and Steel Dynamics (STLD) produce steel through EAFs (electric arc furnaces). In contrast, the United States Steel Corporation (X) mainly produces steel in BFs (blast furnaces). An EAF gives steel companies operating flexibility, and since the fixed costs associated with BFs are higher, they severely impact the profits for steel companies that use them during downturns.
When the capacity utilization rates are low—as they are currently—the profitability of steelmakers using blast furnaces comes down. On the other hand, steel companies that use EAFs to produce steel generally don’t see huge swings in their profits.
Nucor currently makes up 2.73% of the Materials Select Sector SPDR ETF (XLB). Steel Dynamics makes up 5.1% of the SPDR S&P Metals and Mining ETF (XME) and the 0.33% of the iShares Core S&P Mid-Cap ETF (IJH).
Nucor’s variable cost structure
Nucor, the largest steel company in the US, has a variable compensation structure for its employees, which differs from most of its peer companies, whose employees receive most of their compensation as fixed income. A variable compensation structure serves the dual purpose of increasing productivity through a motivated workforce while keeping a check on labor costs during downturns.
The chart above shows Nucor’s EBITDA (earnings before interest, taxes, depreciation, and amortization). As you can see, the company’s EBITDA margin is much more stable than some of the other steel companies. Only Steel Dynamics, which also produces steel using EAFs, shows comparably stable profit margins across business cycles.
Such stable profit margins help Nucor and Steel Dynamics become better prepared to survive the current slowdown in the US steel industry than some of their integrated peers, such as ArcelorMittal SA (MT) and U.S. Steel.
In the next part, we’ll explore how mini mills might continue to outperform their integrated peers.