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Nucor Corporation Strategic Assessment:  Recommend Nucor Achieve Revenue Growth and Diversification by Investing in International Joint Ventures      

                                           

 March 13, 2014  

Peter (Chien-Tarng) Huang, Kent Joshi, Margaux Thomas, & Caitlin Wright  M E M O R A N D U M  

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To: Daniel DiMicco, CEO, Nucor Corporation  

1. Summary of Strategy Assessment and Identification of Strategic Issues  

Nucor is a highly innovative and largely U.S.-based steel producer. Its domestic sales

drive approximately 89% of revenue. However, Exhibit 3 shows Nucor’s revenue growth is

slowing. Specifically, 2012 revenue growth is half compared to 2011. As such, this decline in

revenue growth may be attributed to Nucor’s focus on reducing operating costs through

technological innovation as opposed to considering international expansion opportunities.  

Exhibit 2 describes Nucor’s strengths and weaknesses, as well as opportunities and

threats. Nucor’s domestic success is notable and its cost-conscious strategy (Exhibit 1) has

allowed the organization to maintain a considerable amount of its revenue (Exhibit 3). However,

the commodity nature of steel, coupled with growing steel exports in the U.S., may lead

consumers to purchase from competitors offering the lowest price further compromising revenue.

Thus, we recommend Nucor grow its global market share to increase and diversify revenue

streams, in lieu of focusing solely on cost-reduction within its current market.  

2. The Key Strategic Issue, Options, and Recommendation for Action  

Nucor’s key strategic opportunity is to meet demand in international, emerging markets

to increase revenue growth while maintaining Nucor’s current low-cost strategy. An overview of

reviewed options, with advantages and disadvantages of each, are outlined in Exhibit 4B.  

Based on upside potential, reduced risk, and Nucor’s track record of international joint

ventures (i.e. Brazil), we recommend Nucor invest $40M in two joint ventures in an emerging

economy such as Latin America. As part of this investment, Nucor will negotiate with the local

government to secure a high percentage of the local economies steel exports. In exchange, Nucor

will set-up a work exchange training program similar to ‘Nucorizing’, where engineers and

management from the local economies would visit each other and learn best practices without

Nucor giving away innovation secrets or confidential information. Nucor will define its important

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boundaries and rules to ensure trade secrets are not at risk. This will also require extra training for

Nucor employees to help mitigate the accidental exposure of trade secrets or confidential

information.  

However, there are risks to acknowledge. First, international governments are

independent sovereign nations. Despite the contracts Nucor might have in place for the local

economy to procure most of its steel exports from Nucor, the local government could back-out

and change the rules. Second, as Nucor increases its international revenues, it exposes itself to

international economic, social and political risks. A potential risk, such as the local economy

might experience reduced demand for steel, may lead to an unprofitable investment for Nucor

similar to its failed joint venture (JV) with the Rio Tinto Group. Third, Nucor may not be able to

negotiate a deal with the local authority/economy.  

Overall, we recommend Nucor to increase and diversify its revenue captured from

emerging foreign markets. Despite risks, Nucor will mitigate them by remaining largely U.S.

based and by gradually shifting to international revenue source over the long-term.  

         

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 Exhibit 1: Nucor’s Strategy in Detail    Nucor’s Vision: To be a low cost producer of steel and a global leader in innovative steel-making technology.    Nucor’s Mission:  

● To be a low-cost, largely U.S. based producer of steel.  ● To be a global leader in innovative steel making technology.  ● To be opportunistic in constructing new plant capacity that would enable to company to

expand its presence in attractive or existing market segments.  ● To be an environmental steward.    

Nucor’s Goals:  ● Invest $290 million by 2014 in 3 special-quality bar mills (Memphis, Tennessee, Norfolk,

Nebraska, and Darlington, South Carolina) in order to expand its production capacities by a combined one million tons annually  

● Backward-integrate into the production of 6,000,000 to 7,000,000 tons per year of high-quality scrap substitutes (chiefly pig iron and direct reduced iron) at either its own wholly owned and operated plants, or at plants jointly owned by Nucor and other partners  

● Endow close to $1 billion in 2012-2013 year on new technology, plant improvements, and equipment upgrades, in order to modernize production facilities.

 Nucor’s Policies    Culture:  

● Individual Plant Accountability: Nucor incorporates a decentralized organizational structure that enables daily work-related decisions be implemented by on-site plant/general managers. This structure allows local managers more authority to act independently with minimum restrictions.  

● Cost-Conscience: Nucor strives to limit manufacturing and administrative costs in all areas of the organization - from plant construction to top management traveling expenses. Additionally, due to the technological investment and labor efficiency, Nucor is able to produce steel products at a lower cost than competitors.  

● Constant Growth: Nucor seeks to improve its steel-making plant efficiency and production in existing plants and construct new plants in order to become the industry leader. Its highly automated operation process requires less labor, less production steps, and less capital investment. Technologies like thin slab casting process and direct strip casting of carbon sheet steel enables Nucor to achieve higher profitability.

 Leadership Style:  

● Continuous Productivity: “Higher highs and higher lows” (DiMicco). The company uses economic downturns as opportunities to invest in growth opportunities (e.g. plant improvements), with the objective of maintaining long-term value for Nucor’s stockholders. Nucor aspires to have improved returns at every point of the economic cycle, including periods of low steel demand.  

● Strong leadership. Low CEO turnover as Ken Iverson was Nucor’s CEO until 1988. He was recognized as a “model company president”.

 Management Systems:  

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● Employee Incentive Plans: Nucor employs a “pay for performance” incentive plan for employees to earn uncapped bonuses. The Production Incentive Plan rewards weekly bonuses based on weekly outputs of production teams compared to the standard outputs set by the company. Department Manager Incentive Plan rewards managers annual bonuses based on the percentage of net income to dollars of assets employed for their division. The Professional and Clerical Bonus Plan rewards non-production workers based on a division’s net income return on assets. The Senior Officers Incentive Plan pays out cash and stock to senior officers based on Nucor’s annual overall percentage of net income to stockholder’s equity.  

● Egalitarian Approach: Nucor has an emphasis on workforce safety, equality, and teamwork to all its employees from workers to top management. It incorporates a belief that all employees be treated fairly and rarely lay off workers. It employs an employee center strategy where employees can voice their opinions to the plant and Nucor will take those opinions into implementations. This creates a very close worker-management relationship. Nucor also strives for teamwork in its plants as incentives are paid based on team’s performances. Nucor believes an egalitarian culture and highly motivated employees are the keys to extraordinary productivity.

● Control Business Cycles: During business downturns, Nucor was effective at keeping their workers employed by using them to repair and upgrade machinery and equipment.

 Structure:  

● Pricing Structure: Due to the commodity nature of Nucor’s steel products, the sales strategy is split 50% contract customers (contracts lasting 6 to 12 months with price adjustment flexibility due to changing raw materials cost) and 50% monthly customers at prevailing spot market price. The same payment terms are given to both types of customers, and customers pay all shipping charges.  

● Product Structure: Nucor’s product strategy is to grow its offerings wider and wider. It believes in “climbing a mountain without a peak” in terms of its constant product and technology improvements and upgrades. Due to the characteristic of steel products being a commodity, Nucor recognizes that it needs to keep on growing its product line in order to offer the most complete package with the most appealing offerings. Throughout the years, Nucor expanded its products from steel mill products to finished steel products to “value-added products”. Nucor’s customer base includes retail stores, shopping centers, automotive, commercial/industrial buildings, and infrastructures due to the broad range of products.

● Foreign Sales Offices, Joint Ventures and Acquisitions: Nucor’s global growth strategy consists of two elements: exporting and joint ventures/acquisitions. In order to increase international revenue, Nucor began establishing foreign sales offices internationally for exporting. Nucor’s international growth strategy progressed into joint ventures with foreign partners, with the objective of growing Nucor’s international market share, customer base, and lineup of product offerings.  

 Total Quality Management (TQM):  

● Technological Investment: Nucor heavily invests in 2 types of steel-making technological innovations, disruptive and leapfrog innovations, with the objective of reducing equipment outlays and operating expenses, and producing a more environmentally-friendly product.  

● Backward Integration: Nucor recognizes that the biggest cost and price uncertainty lays in the price of raw materials required in making steels. Nucor aims to have greater cost controls on raw materials by integrating backwardly (providing raw materials supplies on

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its own instead of relying on outside iron suppliers). Nucor launched joint ventures, acquisitions, and partnerships to supply cheaper raw materials and transportation costs to its mills. Nucor’s value chain (anchored in using electric arc furnace technology to recycle scrap steel) involved far fewer production steps, far less capital investment, and considerably less labor than the value chains of companies with integrated steel mills that made crude steel from iron ore.

● Environmental Awareness: Nucor commits to being the global leader in preserving the environment. It incorporates facilities with the most energy-efficient systems to reuse its energies. It initializes waste/water recycling systems and monitors its environmental objectives and targets constantly. A big environmental benefit of the Castrip process was cutting greenhouse gas emissions by up to 80 percent. Nucor installs a measuring device called opacity monitor that will give accurate readings on the air quality of its mills. Opacity monitor helps Nucor to constantly monitor its emissions.

                                   

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 Exhibit 2: Nucor’s SWOT Analysis    Strengths   • Low cost production achieved from advanced technological solutions  

• Innovation/Technology Excellence has resulted in a 50% labor cost savings and automated most processes.  • Streamlined Organizational Structure  • Total quality culture and performance metrics where the line worker can implement changes without managerial approval (kaizen)  • Strong and well respected CEO leadership by employees and market  • Profit-based compensation plans  • Broad product offering  • Acquisitions enable economies of scale and scope  • Low employee turnover and absenteeism  • Modern updated plants to enable the highest efficiency and quality control  • ISO compliance plants reduces risk  • Deep water transportation access for lower delivery cost  • Strong track record: leader in the U.S. steel production since the 1960s  • Financial Strengths:   - Ranked #1 in world for credit rating and credit outlook by S&P in 2012   - Positive and increasing net profit margin  

- Growing revenue  - Declining Cost of Goods Sold (COGS) as a percentage of income  - Strong current and quick ratio  - Strong inventory turnover compared to competitors suggests Nucor has efficient inventory management  - Low collection period compared to competitors  

 Weaknesses   • Slowed revenue growth rate  

• Weak support from U.S. government compared to foreign countries  • Uncapped performance incentives  • U.S. based manufacturing footprint  • Workers are paid in USD (usually appreciated compared to other currencies)  • Higher tax rates in the U.S. due to regulations compared to protected industries abroad  • Short-term contracts  • Decline in plant utilization  • Forcing newly acquired companies to comply with Nucor standard operating procedures

(SOPs)  • Financial unviable raw material Joint Ventures  • Financial Weaknesses:  

- Slowing revenue growth  - ROE under performs competitors  - Return on assets (ROA) under performs competitors  

 Opportunities   • Growing steel market (4.4%)  

• Growing international steel demand/ expand internationally esp. in South America  • Additional cost-savings through the reduction of potentially excess compensation  

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• Opportunities in the U.S. Steel Fasteners/Rebar Products (90% imported)    Threats  

• Steel is a commodity market where firms must compete on price not quality  • Foreign government subsidies  • Low labor costs abroad  • Increasing U.S. steel imports (22%)  • Undercut by Illegal dumping by foreign countries  • Unstable demand for steel  • Prevailing market price determined by demand-supply  • Industry consolidation is creating large economies of scale for competitors  • Slow improve in domestic demand for steel (slow increase in capacity utilization rate)  • Opportunity to improve plant utilization  • Lobby U.S. government for additional protectionists tariffs  • Expand international manufacturing footprint    

                                                             

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EXHIBIT 3: Analysis of Nucor’s Financial Performance  Note: Negative percentages are displayed with a minus sign in the front. Negative absolute numbers are displayed in parenthesis.    Horizontal and Vertical Analysis  

 In the vertical analysis above, we can see that Nucor’s cost of products sold has significantly declined from 2009 to 2011. In 2009, Nucor’s cost of products sold was 98.6% of their total revenue, but in 2011 cost of products sold was only 90.3% of total revenue. This significant drop suggests the firm was able to achieve cost savings likely from operational improvement projects (e.g., improved efficiency, bulk procurement of raw material, “close cutting” the optimization of raw material during milling, time savings during manufacturing). As a result, Nucor’s gross margin increased from 1.4% in 2009 to 9.7% in 2011. Additionally, in both 2011 and 2010 Nucor, has positive net income growth, equating to 3.9% and 0.8% of total revenue. Nucor’s other cost items have not changed significantly. Note: FY 2009 has negative percentages since their overall costs exceeded their revenue.    The horizontal analysis shows Nucor’s revenue is growing year over year, albeit at a slower rate. Revenue growth from 2009 to 2010 was 41.59%, but from 2010 to 2011 revenue grew only 26.37%. Revenue growth in 2011 was 37% less, just short of half, the revenue growth seen in 2010. Cost of products sold grew 130.97% in 2011 from 2010. However, it too grew at a slower rate than previous years. In fact, in 2011 it grew 71% slower than the growth of cost of products seen in 2010.    The vertical and horizontal analysis highlight Nucor’s increase in gross margin and net income was largely driven by savings achieved from its reduced cost of products sold rather than actual revenue increases. Additionally, since we know the U.S. steel market is growing, Nucor’s slower revenue growth suggests they are losing market share within the U.S.    

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Financial Ratios  

 We have seen tremendous improvement in Nucor’s financial health from 2010 to 2011. The above table shows Nucor is financially sound with a profit margin of 3.9% in 2011 compared to competitor’s profit margin of 3.8%. Although, Nucor’s return on equity underperforms competitors at 10.4% compared to 11.0%.    Nucor’s current ratio was 2.80 and 3.90 in 2011 and 2010. A current ratio above 2.0 suggest to creditors and the market that Nucor could easily repay its short-term loans or liabilities. While Nucor’s current ratio declined in 2011, it’s still above its competitors. The quick ratio is a more stringent measure of Nucor’s ability to repay its loans as it excludes inventory. While Nucor’s quick ratio declined in 2011 to 1.97, Nucor is well above its competitors at 1.2.    Nucor’s strong inventory turnover ratios suggests Nucor has an efficient inventory management and forecasting program, exceeding the inventory turnover rates compared to its competitors. Nucor also outperforms competitors when it comes to collecting accounts receivables from customers with a 31.18 collection day period in 2011, compared to competitors who average a 43.8 collection day period. This may also be due to the fact that Nucor focuses on short-term contracts, while competitors might focus on long-term multiple month or year contracts for steel.    While Nucor’s total asset turnover is improving, it was 1.37 in 2011 and 1.14 in 2010. An optimal total asset turnover would be 3 .0 – 4.0. Since Nucor is almost one-fourth less than expected, it suggests Nucor has assets that are producing less net income per asset dollar, an area of improvement, which is in-line with Nucor’s reported plant utilization levels. Additionally, Nucor’s return on assets of 5.3% in 2011, and while improving, it is still less than competitors and an area for concern.    In terms of debt and financing, Nucor’s assets are financed almost evenly between its liabilities and shareholder equity with a 47.1% debt ratio. Despite Nucor’s financial strength, its return on equity is less than competitors at 10.4% compared to the 11.0 return on equity of competitors.  Sources & Uses

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   The above sources and uses analysis shows a negative cash balance from FY2010 to FY2011. The negative cash flow is caused by an increase in non-cash assets such as inventory, short term investments and accounts receivable, these assets require cash so they reduce the cash balance. Additionally, the increase in liabilities from accounts payable, salaries and wages, and accrued expenses are liabilities that use up cash and create a negative net cash balance.      

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 EXHIBIT 4A: Assessment of Nucor’s Strategy    Question 1. Do all elements of the strategy itself fit together? Are there actual or potential built-in contradictions? Most importantly, does the strategy make sense?    Nucor’s strategy is to be a low cost largely US based producer of steel as well as be a global leader in innovative steel making technologies. However, there are a few built in contradictions.    First, Nucor has an uncapped compensation system that allows workers to makes 50% - 150% of their base pay in addition to a host of fringe benefits (e.g., 401K plans, tuition reimbursement, and profit sharing). Nucor claims to execute its low cost leadership by simply furnished executive offices, no company cars or executive perks. Yet, Nucor provides its blue collar manufacturing works with financial incentives and fringe benefits that more than equate to those of a college educated white collar worker. Today, COGS is 90.3% of total revenue (refer to Exhibit 3). Nucor’s employment compensation and benefits scheme is inconsistent with its low cost strategy.    Second, we question the largely U.S. based part of Nucor’s strategy. Nucor is competing in a global market where labor rates are 1/10 the cost of U.S. rates, where countries have devalued currencies compared to the U.S. dollar and where foreign governments provide direct and indirect subsidies. Achieving a low cost position with a largely US based manufacturing presence will be incredibly difficult if they rely on technology innovation alone to level the playing field.    Third, one of Nucor’s strengths is innovation (refer to Exhibit 2). However, in looking at their income statement they don’t appear to have a line item for R&D. While R&D could be rolled-up into “Marketing, administration and Other Expenses”, this expense line has remained relatively constant (refer to Exhibit 3). As global competition increases, Nucor should think about increasing their investment internal spent on R&D efforts.    Fourth, Nucor has low ROA (refer to Exhibit 3) and room for improvement in plant utilization rates. Why is Nucor importing 90% of their steel fasteners instead of producing them?    Question 2. Does the company have the strengths needed to pull off the strategy? Or are there significant weakness that will have to be remedied?    Nucor’s strategy is to be a low-cost and global leader in innovative steel making (refer to Exhibit 1). While Nucor has successfully achieved disruptive technology innovation and leapfrog technology innovation that have reduced labor costs by 50%, Nucor still overpays its employees in compensation and benefits. This is a significant weakness that will need to be remedied if Nucor desires to maintain its low-cost position against both U.S. and international competitors.    In terms of Nucor’s strategic focus on innovation and efficiency, Nucor definitely excels. Not only does Nucor have a strong track record of innovative technologies, but they have created a culture and organizational structure to drive it (Exhibit 1). Nucor’s relatively flat hierarchy, accountability metrics for plant managers, ability for line workers to make real-time judgment calls foster innovation and efficiencies foster innovation and efficiency throughout the company to a level that emulates the Japanese Kaizen manufacturing best practice.    

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Question 3. Does the strategy position the company well to take advantage of eternal opportunities? And to defend itself against threats?    Nucor’s strategy does not position it well to take advantage of the international opportunities and defend against international competitors importing steel into the US market. In order for Nucor to be a global leader, it will need to have the support of international governments. While Nucor currently has creating trading offices abroad, that is not enough. The presence of a trading office (refer to Exhibit 1) will not convince and international government to support and protect Nucor business with just a trading office. A company needs to be viewed as providing jobs to the country with a local manufacturing presence. Without jobs, there is no incentive for the country to purchase steel from Nucor when they could buy it for cheaper from China for example. Furthermore, Nucor’s high compensation plan does not position Nucor well against steel imports (currently 22% of the U.S. steel market), even with U.S. imposed tariffs.    Question 4. Has the strategy created a competitive edge?    We believe the key industry success factors are:  

● New acquisitions  ● Commercialization of new technologies  ● New plant construction  ● Continued plant upgrades  ● Cost reduction efforts  ● Greater control over raw material costs  ● International growth through joint ventures and foreign sales offices  ● Obtaining multiple products through one company.  

 Nucor has been able to compete effectively in several of these industry success factors. Specifically, new acquisitions, commercialization of new technology, cost reduction efforts in terms of plant efficiency and low cost production, and international growth through joint ventures and foreign sales office are areas where we feel there’s a payoff to the customer and where Nucor potentially is better than their customers.    Question 5. Does financial performance indicate the strategy is successful?    Nucor’s financials highlight while the company is financially sound today and generating positive net income (3.9% of revenue in 2011), its revenue growth is rapidly slowing and Nucor is underperforming competitors in regards to its return on assets and equity (refer to Exhibit 3). In order for Nucor to sustain its net income growth (480.3% in 2011), it will need to consider new ways to grow its revenue and or further cost reduction strategies that will increase their gross margin.    Question 6. Is the strategy workable? Where will it leave the company if left unchanged?    In the long-term, Nucor’s strategy is not sustainable. Nucor is relying on innovative disruptive technologies to level the playing field against substantially lower cost global competitors (refer to Exhibit 1). Nucor is competing in a global market where labor rates are 1/10 the cost of U.S. rates, where countries have devalued currencies compared to the U.S. dollar and where foreign

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governments provide direct and indirect subsidies. Achieving a low cost global position with highly compensated and largely US based workers will be incredibly difficult if Nucor relies on technology innovation alone.                

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 EXHIBIT 4B: Assessment of Nucor’s Options    

               

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 EXHIBIT 5: Pro Forma Income Statement  

 In the above pro forma, we assumed two scenarios: 1) status quo and 2) our recommendation for a joint venture investment. For the status quo scenario, we assumed 2012 revenue would grow at the same rate as the 2011 growth rate of 26.37%. We assumed the cost structure would remain constant, compared to 2011 based on a percentage of each cost line item to total revenue. The net profit margin remained at 3.9%.    For the second scenario, we assumed our recommendation to invest $40M into two separate joint ventures was implemented. $40M was selected since Nucor allocated $10M to the Brazilian Joint Venture in 2003. We doubled the investment requirement since the investment was made ten years ago and it allows for a more significant role than 22% ownership. We assumed the cost of the joint venture could be depreciated using the straight-line method over ten years. Since 11% of our revenue today comes from international markets, we assumed this joint venture would grow Nucor’s current international revenues by 15%. Revenue growth would be achieved through contracted deals with governments that would promise to purchase Nucor steel for exported steel contracts, as a result of Nucor’s investment in the local economy. The deal would also include a promise and work exchange program between the two local economies and Nucor. The remaining cost line items, were held constant to the status quo scenario as none, except taxes, grew with the additional revenue from the JV. The result of our recommendation is a net profit margin of 5.1%, an increase over FY2011. Additionally, we believe this long-term investment in international markets that will yield increased revenue opportunity, diversification and growth in the out years.