After seeing the recently-announced deal whereby Cleveland-Cliffs (CLF) is purchasing the US division of ArcelorMittal (MT), I wanted to revisit Nucor (NUE) to have a closer look at how this large steel producer is getting through the fallout of the COVID-19 pandemic. And I was positively impressed with what I saw as although Nucor definitely saw some impact of the weaker economy, the company’s cash flows remain much stronger than I originally anticipated and now Nucor also is guiding for a strong Q3 performance, I may very well establish a long position for its current 3.5% dividend yield.

ChartData by YCharts

Nucor’s financial performance remained very strong, despite the pandemic

In the second quarter of the year, Nucor’s revenue did decrease by in excess of 25% to $4.4B, but its COGS and overhead expenses decreased at a similar pace. This obviously wasn’t sufficient to keep the pre-tax income stable and the pre-tax profit dropped to $181M, a 66% decrease compared to the result in the second quarter of last year. The net income of Nucor in Q2 came in at almost $109M or 36 cents per share attributable to the Nucor shareholders.

Source: SEC filings

Definitely not great but a strong improvement compared to the first quarter although the low net income in Q1 was predominantly caused by an impairment charge. The net income in H1 2020 came in at just over $129M, but this would have been north of $325M and north of $1/share excluding that impairment charge.

Although the net income wasn’t spectacular, I was expecting Nucor’s cash flows to remain pretty robust as the very low net income as predominantly caused by the non-cash expenses like the almost $300M in impairment charges.

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And indeed, Nucor’s operating cash flow came in at $1.35B although we still need to deduct a few other elements here. Adjusting the reported operating cash flow for changes in the working capital and the payment to non-controlling interests, we end up with an adjusted operating cash flow of $956M.

Source: SEC filings

And as you can see in the image above, the total capex level was just over $777M which results in a free cash flow result of approximately $180M or just under $0.60/share. Indeed, about 50% higher than the 0.42 EPS recorded in the first semester, but there’s more than meets the eye here.

I expect further dividend increases given the low maintenance capex requirements

In Nucor’s case, there’s a massive difference between the total reported capex and the sustaining capex as the company is investing billions of dollars in expansion and efficiency. Have a look at the near-term growth investments planned at Nucor, which are well underway (and finished by now):

Source: company presentation

And although the investments mentioned above are nearing the completion phase, Nucor has earmarked an additional $2.5B in investments for projects that should be completed in 2021 and 2022:

Source: company presentation

Of course, we can reasonably expect some of these projects to be delayed as Nucor is throttling its investment in growth this year based on the anticipated incoming cash flows, but one thing is for certain: The high capex bill is predominantly caused by the high amount of money invested in growth.

Indeed, in the same presentation, Nucor’s management team indicated the total maintenance capex in 2020 is estimated to be just $500M:

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Source: company presentation

This means that on a normalized basis, the maintenance capex is just $250M per semester and the $777M in capex recorded in H1 2020 includes about half a billion dollar in growth initiatives. And this has a very important implication as it means the sustaining free cash flow in H1 2020 was approximately $700M or $2.30/share.

As Nucor pays a quarterly dividend of just over 40 cents per share, the dividend is more than fully covered by the sustaining free cash flow, but Nucor’s net debt will very likely increase throughout H2 2020 and 2021. Not because Nucor can’t afford the dividend, but because it’s spending billions on growth initiatives.

Investment thesis

The main unknown at this point is obviously how the US steel markets will evolve in the next few quarters and years. Nucor has been guiding for an EPS north of $0.50 in the third quarter, and as the sustaining capex should remain stable at approximately 70% of the depreciation charges, we can reasonably expect the sustaining free cash flow to exceed the EPS (again).

Nucor’s current dividend yield is just over 3.5%, and given the strong sustaining cash flows, I consider this dividend to be safe. I’m exploring the possibility to write an out of the money put option in an attempt to get my hands on an initial position at a lower cost base and a P40 for November at an option premium of around $1 and a P37.5 for January 2021 with an option premium of $1.35 both look pretty appealing.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I currently have no position in Nucor but I am considering writing some out of the money put options.