Nucor Stock Downgraded: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Just how bad is the market for steelmakers today?

Here's a hint: Last week, Credit Suisse downgraded both AK Steel and Steel Dynamics. Yesterday, Deutsche Bank echoed the downgrade of Steel Dynamics -- and added U.S. Steel and Nucor (NYSE: NUE) to the list. Today, Bank of America/Merrill Lynch piled on, adding yet another downgrade for Nucor.

Things are getting so bad, in fact, that B of A is seeking a trademark for a new term to describe it: "Steelmageddon."

The trouble with steel

Steel is a commodity. Left to its own devices, steel supply will ordinarily tend to flow from places where it can be produced cheaply to places where it costs more to produce, displacing higher-cost producers in favor of lower-cost producers.

For consumers, this sounds like a good thing. Cheaper steel means cheaper goods made from steel, such as cars and washing machines. For producers -- not so much. And this is why, early last year, the Trump administration imposed 25% tariffs on "a substantial portion" of imported steel -- to protect U.S. steelmakers from foreign competition.

Initially a boon for the industry, permitting steelmakers to raise prices and reap profits (because foreign competition couldn't undercut their prices), the steel market was shaken earlier this month when the U.S. lifted its tariffs on Canadian and Mexican steel and cut tariffs on Turkish steel in half. At the same time, the Trump administration's affinity for using tariffs as a tool of foreign policy has sparked a trade war with China that is dampening economies across the globe, depressing demand for steel...and pushing prices right back down again.

Result: Barron's reports that "new" steel prices are now down 19% year to date, while "scrap" steel (which steel minimill makers like Steel Dynamics and Nucor melt to create new steel) prices are down 14%. Buyers are cutting their orders for steel. Producers are cutting their output. Neither buyers nor producers seem to have any idea when the steel cycle might bottom out.

"Steelmageddon," indeed.

Bank of America weighs in

Responding to this dynamic, Bank of America announced today that it has initiated a "sweeping review" of U.S. steel stocks based on the "lower near-term prices" it's seeing in steel sheet and rebar. Despite production cuts responding to the lower prices, B of A says it sees a "looming glut" in steel supply, as demand is falling faster than production.

Bank of America calls this phenomenon "Steelmageddon," and based on "a DCF analysis," the analyst says it thinks it might last for as long as three years -- but "assume[s]" there will be a recovery in steel prices at some point "afterward."

In preparation for the three-year wait, the banker is downgrading Nucor stock to underperform and cutting its price target to $50, as reported today by

What it means to investors

And yet, is this an overreaction -- not just by Bank of America, but by its peers at Credit Suisse and Deutsche Bank as well?

After all, even if prices are falling, and Nucor may not be as profitable over the next few years as it was in 2017 and 2018 (over the course of which, Nucor reaped nearly $3.7 billion in profit), it kind of looks like this risk may already be priced into the stock.

At $15 billion in market capitalization today, Nucor sells for a bare six times trailing earnings. And although most analysts who follow the stock agree that profits are likely to fall over the next couple years, they still believe Nucor will earn some profit -- probably close to $5 a share next year for example, keeping its valuation below 10 times forward earnings. Factor in a 3.2% dividend yield and an 8.5% consensus projection for long-term earnings growth, and I have to say that Nucor stock still looks pretty cheap to me today.

On top of that, just yesterday President Trump appeared to renege on his promise to lift Mexican steel tariffs, reimposing a 5% tariff on all Mexican imports, "until such time as illegal migrants coming through Mexico, and into our Country, STOP" -- and promising to raise tariffs even more over time. When you combine this latest development with the potential for the president surprise us again -- perhaps by finally delivering on his promise to enact a steel-hungry infrastructure plan -- it's possible, just possible, that steel prices won't end up as bad as analysts fear, and Nucor stock could still be a better investment than they imagine.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.