The steel industry is a deeply cyclical sector. The last downturn was particularly difficult, as it was both deep and long. It also provided the perfect backdrop for why U.S. steel industry giant Nucor Corporation (NYSE: NUE) is a better option for long-term investors than United States Steel Corporation (NYSE: X). Here's what the downturn taught us.
In the face of adversity
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The last downturn started after the 2007 to 2009 recession. In 2009 almost every major steel mill with U.S. exposure lost money, with the notable exception of globally diversified ArcelorMittal SA. Both Nucor and US Steel dipped into the red. But what happened in the following years was, perhaps, more interesting. Nucor quickly got back into the black in 2010 and stayed there. US Steel has lost money in seven of the last eight years.
This isn't exactly a fair comparison because the two companies have very different operations. Nucor's business is built around electric arc furnaces, which are more flexible than the blast furnaces that underpin US Steel's operations. To simplify a bit, Nucor can ramp production up and down with demand and stay in the black while US Steel really needs to run its blast furnaces at high utilization rates if it wants to remain profitable. In a cyclical industry like steel, I'd rather stick with the more flexible player. In this case that's Nucor.
Working with the workers
Another key differentiation here is that Nucor has a unique pay structure in the steel industry. The company estimates that roughly two-thirds of employee pay come from "pay for performance" bonuses. This means that employees do very well when Nucor is doing well, but during bad years they make less money. There are two important takeaways here.
First, employees are incentivized to do the best work they possibly can because better work will translate into better pay. However, when times are tough they will make less -- reducing salary costs for Nucor when it most needs a break. Which is one of the reasons why Nucor's margins have historically trended at the high end of the industry.
Most of US Steel's employees are covered by collective bargaining agreements, which tend to be much more rigid when it comes to adjusting pay levels. Unions aren't a big issue at Nucor and give the company a lot more flexibility, which its pay structure highlights. And it's another good reason to select Nucor over US Steel.
Using the downturns
A third reason long-term investors should like Nucor over US Steel was put on clear display during the most recent downturn. Nucor makes a point of using industry soft spots to opportunistically invest for the future. That means both investing in its facilities and expanding via acquisition -- when prices are likely to be cheaper.
During the recent downturn, Nucor was particularly busy. It built a direct reduce iron ore facility, upgraded a number of mills, and announced plans to expand in Mexico and Canada. It also bought steel foundation distributor Skyline Steel, flat rolled steel mill Gallatin Steel, two cold finished bar mills (one in Georgia and one in Ohio), a plate mill in Texas, and three pipe and tube mills, which allowed it to build a completely new business segment. In 2017 it announced plans to upgrade two more mills and agreed to acquire St. Louis Cold Drawn, Inc., which serves the auto industry through mills in Missouri and Mexico.
US Steel's focus during the downturn was on cutting costs and protecting the balance sheet. An image is worth a thousand words here. Look at the chart above, US Steel's capital spending has trended lower and lower over the last few years. Nucor's capital spending, meanwhile, has remained fairly constant with a couple of big peaks for notable expansion efforts.
In fact, when US Steel reported first quarter earnings then CEO Mario Longhi noted that, "This remains a cyclical industry and we will not let favourable near-term business conditions distract us from taking the outages we need to revitalize our assets in order to achieve more reliable and consistent operations, improve quality and cost performance, and generate more consistent financial results." That was taken by investors as an admission that the company hadn't invested enough in its business during the downturn and was now playing catch up -- right when the U.S. steel market was starting to recover. Nucor's use of downturns to improve its business is clearly the better long-term plan.
That's enough for me
There are more reasons to like Nucor over US Steel, but these are three of the big reasons why I own Nucor and not US Steel. I prefer companies that have faced adversity and proven that their flexible business models can survive. That work with their employees, in good times and bad, to keep the business moving forward. And that act opportunistically to grow over time, including through the tough years. Nucor, in my opinion, is the hands down winner here no matter how iconic US Steel's name might be.
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