Nucor, Executive Compensation and Dividends

Nucor Corporation (NUE: $152/share) is a stock I discovered while studying CMC. Like CMC, its executive compensation aligns shareholder and management interests. It has the added advantage of generating free cash flows (FCF) in such abundance that there is scope for growth in dividend payments. The stock earns a “very attractive” rating according to my stock rating methodology. The underlying data for this report can be viewed in the accompanying spreadsheet.

Growing Revenue and NOPAT

Since 2019, Nucor has compounded revenue by 7.7% and net operating profit after tax (NOPAT) by 21.2% a year. NOPAT margin has risen from 6.4% in 2019 to 11.6% in the last twelve months (LTM), while the firm’s invested capital turns have declined from 1.4 to 1.2. Given that return on invested capital (ROIC) can be calculated as,

ROIC = NOPAT margin x invested capital turns = (NOPAT/Revenue) x (Revenue/Average Invested Capital)

the net impact of rising NOPAT margins and declining invested capital turns has been an increase in ROIC from 9% to 13.8%.

Free Cash Flows Support Dividends

Nucor has increased its quarterly dividends from $0.40/share in Q1 2019 to $0.54/share in Q2 2024. In the LTM, investors can earn $2.16/share in dividends on an annualised basis, with a yield of 1.4%. The quality of dividends depends upon a firm's long-run free cash flow (FCF) generation. The greater the gulf between FCF generation and dividend payments, the greater the ability of management to increase future dividends, whereas if dividends are greater or equal to FCF generation, the scope for growth is compromised and a firm may find it needs to scale back its dividends. In that vein, one observes that since 2019 Nucor has generated $14.2 billion in FCF, some 35% of its enterprise value, and paid out $2.8 billion in dividends.

Shareholder and Management Interests are Aligned

The economist Michael C. Jensen, the greater unraveller of the mystery of how executive compensation is tied to shareholder value, died this year. It is by a curious coincidence that my previous piece on CMC hinged upon the fact that its executive compensation is tied to the creation of shareholder value. This is true also of Diamond Hill, whose management and analysts are invested in the business and invest alongside clients. I could extend this to include Meta Platforms, a firm controlled and run by Mark Zuckerberg, a man whose fortune is wholly tied to the success of the business. Nucor follows in that tradition. Like its peer competitor, CMC, and other firms in the basic materials industry, Nucor long tied its executive compensation to ROIC. In my piece on CMC, I noted that,

The stock market allocates capital to where it may be most productively used, which is to say, where it can earn the highest ROIC. There is abundant evidence that a management that focuses on ROIC delivers value for shareholders:

Per Nucor's 2024 Proxy Statement, "Executive Officers should be compensated through pay elements (base salaries and annual and longterm incentives) designed to create long-term value for our stockholders and to reinforce a strong culture of ownership." Consequently, 25% of Nucor's annual incentives, and 50% of the cash and restricted stock that make up the long-term incentive plan (LTIP) to annual "return on average invested capital" (ROAIC), a form of ROIC, assessed against the performance of a "Steel Comparator Group".

As discussed, Nucor has grown ROIC from 9% in 2019 to 13.8% in the LTM. The firm's economic profit, measured as,

Economic Profit = (ROIC – WACC) x Invested Capital

demonstrates the extent of value creation that management has overseen: Nucor's economic profitability has risen from $269 million in 2019 to $1.2 billion in the LTM, compounding at 34.8% a year.

Nucor Has Room to Run

At the current price, Nucor has a price-to-economic book value (PEBV) of 1.05, which means that the market expects Nucor to never grow NOPAT by more than 5% from its current level, despite the firm's 5-year record of compounding NOPAT at over 21% a year. Using my reverse discounted cash flow (DCF) model , I analyse the implied value of the stock based on conservative assumptions about Nucor’s future growth in cash flows.

In the first scenario, I quantified the expectations baked into the current price. I assume,

  • Nucor maintains its current NOPAT margin of 11.56%, and
  • revenue declines 10.68 in 2024 and grows 1.74% in 2025 and 6.31% in 2026, equal to consensus estimates, and 6.31% thereafter

In this scenario, Nucor has an implied competitive advantage period (CAP) of less than a year. 

If one assumes that:

  • Nucor's NOPAT margin rises to 14.08%, its 5-year average and
  • revenue grows revenue by 7.68%, its 5-year revenue CAGR

The stock is worth $236.32 today, a 55% upside to the current price.

If, on the other hand, one assumes that

  • Nucor's NOPAT margin is 14.67%, its 3-year average
  • revenue declines by 2.17% a year, its 3-year revenue CAGR

The stock is worth $223.81 today, a 46.4% upside to the current price. 

Impact of Footnotes Adjustments and Forensic Accounting

Here below are details of adjustments made to Nucor's quarterly reports for the LTM period:

Income Statement: I made $530.4 million in adjustments to calculate NOPAT, with the net effect of adding $360 million in non-operating income. The adjustments are equal to 15% of Nucor's GAAP net income.

Balance Sheet: I made $8.74 billion in adjustments to calculate invested capital with a net increase of $6.1 billion. The largest of these adjustments was $3.8 billion in excess cash, equal to 11.1% of Nucor's reported assets.

Valuation: I made $13.15 billion in adjustments with a net effect of decreasing shareholder value by $5.6 billion. Aside from total debt, the largest adjustment to shareholder value was $1.2 billion in estimated deferred tax liabilities, representing nearly 3.4% of Nucor’s market cap.

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