New Trade $NUE – Skeptical of Management’s Steely Disposition

by Enis July 24, 2013 3:20 pm • Commentary

In this morning’s Macro Wrap, I highlighted Chinese weakness sticking out like a sore thumb in the global economy.  One of my main takeaways was:

First off, I don’t expect much of a rebound in industrial commodities or their related stocks as long as Chinese data remains disappointing (CAT’s weak results this morning are more confirmation of that).  Even though some are speculating that the weak data might be a reason for stimulus, Chinese policymakers seem intent on pursuing their rebalancing from fixed investment towards consumption, no matter the short-term difficulties (last night’s article:  China Bans New Government Buildings in Five-Year Crackdown).

Along those lines, we have had some success this year fading China-related stories.  Whether it’s been in currencies (FXA) or stocks (CAT or CMI), the internationally-exposed names have struggled.  One sector that we have not touched on either side this year is steel.

China accounts for almost half of the world’s steel market (accounting for about 45% of both consumption and production).  Here is the pie chart for global steel consumption share in 2012, courtesy of the

Screen Shot 2013-07-24 at 2.27.39 PM


Given that China is the behemoth in the market, when it stumbles, the entire market shakes.  The key risk for the global steel market is that Chinese consumption declines over the next year as construction slows, which causes Chinese producers to flood global markets with cheap steel.  Chinese capacity has increased massively in the past decade (China was about 15% of global production 10 years ago, vs. 45% today).  That capacity increase has coincided with increased demand.  If the demand falters though, the existing production will be searching abroad for customers.

Steel producers in the U.S. have been major underperformers for years now.  They’re all flat to down over the past 4 years as the steel market has struggled.  Nucor (NUE) is by far the largest U.S. steel producer by market cap (almost $15 billion).  It has held up much better than its smaller peers (like X) due to a more flexible cost structure, higher quality production capacity, and no pension issues.

However, on its earnings report on Friday, NUE missed earnings estimates (0.27 vs. 0.30 expected), even though revenues were a bit stronger.  Average sales price per ton was down 7% compared to 2012.  NUE has done an admirable job containing costs as steel prices have moved lower, mitigating the earnings impact.  But steel mill utilization was still down to 73% vs. 77% in 2012.

Nevertheless, the company voiced a positive tone in its earnings release:

We currently expect to see a modest improvement in earnings for the third quarter of 2013.  We expect to see improvements in sheet steel pricing, which dropped to its lowest level since November 2010 in June but has since begun to slowly rebound…The automotive and energy markets remain strong, while the construction market remains challenged.  We also expect to see increased earnings from our downstream businesses in the third quarter, continuing the upward trend observed in the second quarter.  Our David J. Joseph operations are expected to benefit from the bottoming of scrap pricing in the second quarter.

Nucor management seems confident enough to call bottoms in both sheet steel pricing and scrap pricing.  They are also extrapolating better trends in the downstream business.  Management might be right.  But it’s a dangerous game of raising expectations on their part.  Moreover, continued weak Chinese numbers might send steel and scrap pricing to new lows later this quarter, in which case NUE management will be in serious trouble ahead of its next quarterly report.

Most ominously, analyst estimates for 2014 and 2015 are anticipating significant earnings growth, expecting a rebound in the global steel market with the view that 2013 is the trough.  The stock has held up despite recent weak results due to those expectations.  It all seems like a setup for major disappointment to me.

NUE has been a range bound stock over the past 5 years:

5 year weekly chart of NUE, Courtesy of Bloomberg
5 year weekly chart of NUE, Courtesy of Bloomberg

The stock has essentially traded between 30 and 50 since 2009.  Since its bottom around 30 in the fall of 2011, the stock has been in an uptrend, but was unable to breach its 2011 high around $49 earlier this year.

A break of the 200 day ma and the trend line, both around $44, would likely signal a new downtrend for NUE.  Any downturn in steel prices from here would be the obvious catalyst for such a break.  

TRADE: NUE ($45.69) Bought Sept 46/42 Put Spread for $1.25

-Bought 1 Sept 46 Put for 1.69

-Sold 1 Sept 42 Put at 0.44

Break-Even on Sept Expiration:

Profits:  Profits up to $2.75 when stock between 44.75 and 42 on Sept expiry, with max profit of $2.75 at 42 or below

Losses:  Up to $1.25 between 44.75 and 46 on Sept expiry, with max loss of 1.25 at 46 or above.

Trade Rationale:  September expiry is enough time for the stock to break that uptrend in my view.  If the stock does fill its gap at 46.50, I will likely close the trade for a loss.  In the meantime, I am putting on the trade with the view that the 2 year uptrend breaks over the next couple months.