Nucor Case

NUCOR MEMORANDUM To: F. Kenneth Iverson and Management Team of Nucor Corporation CC: AGSM Faculty Teams Subject: Investment Decision Date: 04/22/2009 From: 1713898 The Situation In 1986, flat sheet segment contained 52% of US total steel market1. Nucor Corporation, which is a steel minimill well-known for its leadership, efficient operation and well-structured compensation, is showing the interest in the flat sheet segment. At the same time, there are many new thin-slab casting technologies to help minimills enter the new market quickly and cost-efficiently. One of them is from German firm, SMS Schloemann-Siemag, who has consistently introduced its unique technology, Compact Strip Production (CSP), to Nucor. As the chairman and chief executive officer (CEO) of Nucor, F. Kenneth Iverson has to make a decision on whether Nucor should go for CSP plant developed by SMS. The Issue The most salient issue than concerns Nucor and its management team right now is – What is the best strategy for Nucor to target the flat sheet segment? Alternatives 1. Go for CSP plant: Obviously, the most important reason for Nucor to buy CSP technology is that Nucor could take advantage of the huge opportunity of entering flat-sheet market. As the pioneer of CSP application, Nucor would have 2 to 3 years head start to utilize its technology advantage in order to secure a desired market share. Consequently, CSP will help Nucor to achieve its long-term vision: to target the high end of flat-sheet market. The competition of the low end of flatsheet market is increasing due to the interest of many minimills and the low price products of overseas competitors. Aiming at the high end segment is a wise strategy because the high end segment is expected to bring more profits and help Nucor to grow consistently in future. 1 Exhibit 2 – Steel Mill Product Segments: 1986, page 15 of the case 1 However, going for CSP plant option exposes many disadvantages as well. First of all, without expertise in flat-sheet products, Nucor will be not in a good position to compete fairly to expert players. Subsequently, Nucor will face difficulties in new plant operation and possibly be outpaced by integrated mills adopting CSP. Secondly, the resource constraints will not favor CSP. Sharing resources between CSP and the joint venture with Yamato Kogyo might bring in a risk of not enough capital or even worse, bankruptcy. Last but not least, uncertainty of technology is another major concern. The possibility of new plant’s obsoleteness is there and Nucor clearly does not want to pay a huge sunk cost just because it is the pioneer. 2. Not to go for CSP plant: By not going for CSP, Nucor can apply wait-and-see strategy. It allows Nucor more time to watchfully define the target market and wait for a matured and proven thin-slab casting technology. By that, Nucor will be able to avoid a huge sunk cost. Next, Nucor could utilize the resource on the joint venture with Yamato Kogyo. Hence, the risk of capital shortness will be eliminated. In the other hand, Nucor will let go a significant opportunity to capture some shares of flat-sheet market. It might not affect Nucor in short-term. However, in the long-term, assuming many steel producers adopting successfully CSP or other thin-slab casting technologies, Nucor will be pushed to a bad position to compete over. Also, it will take even more time and resource for Nucor to catch up. Recommendation The first alternative is strongly recommended because of the following three reasons. First, even though money is an issue, it is not a big issue for Nucor. With $185 million in cash and short-term securities on hand together with the ability to issue corporate longterm bond2, Nucor is completed able to fund CSP with a strict financial management. Secondly, CSP project is showing a good cashflow even in the case of CSP’s obsoleteness. Assuming that new CSP plant is operating at 100% capacity or 1 million ton per year, Nucor will get hold of 2. 76% of flat sheet market3, which is reasonable. From a simple projection4, new CSP plant is showing a positive cashflow with NPV = $141. 55 mil, IRR = 19%, and payback period = 4. 34 years. Thirdly, the argument that Nucor should not go to flat-sheet market because of its lacking experience is not convincing. Unless Nucor does not want to enter flat-sheet market, the earlier Nucor enter flat-sheet market, the faster it will learn and the better it will sustain in future. Second-last paragraph, page 14 of the case Appendix 3 4 Appendix 4 2 3 2 Appendices 1. SWOT analysis Strengths Leadership Efficient operation Well-structured compensation Culture Weakness Resource constraint No experience in flat sheet product Opportunities Enter flat sheet market Pioneer in thin-slab casting technology Threats Uncertainty about technology Competition, possibly be outpaced by integrated mills adopting CSP . Porter five forces analysis5 The threat of substitute products – buyer propensity to substitute – relative price performance of substitutes – buyer switching costs – perceived level of product differentiation The threat of the entry of new competitors – Existence of barriers to entry (patents, right, etc. ) – economies of product differences – brand equi ty – switching cost or sunk cost – capital requirements – access to distribution – absolute cost advantages – learning curve advantages – expected retaliation by incumbents – government policies The intensity of competitive rivalry 5 MEDIUM MEDIUM HIGH HIGH LOW MEDIUM HIGH HIGH HIGH LOW MEDIUM LOW MEDIUM HIGH MODERATELY HIGH LOW LOW http://en. wikipedia. org/wiki/Porter_5_forces_analysis 3 numbers of competitors rate of industry growth intermittent industry overcapacity exit barriers diversity of competitors informational complexity and asymmetry – fixed cost allocation per value added – level of advertising expense – Economies of scale – sustainable competitive advantage through improvisation The bargaining power of customers – buyer concentration to firm concentration ratio – degree of dependency upon existing channels of istribution – bargaining leverage – buyer volume – buyer switching costs relative to firm switching costs – buyer information availability – ability to backward integrate – availability of existing substitute products – buyer price sensitivity – differential advantage (uniqueness) of industry prod ucts – RFM (Regency + Frequency + Monetary Value) analysis The bargaining power of suppliers – supplier switching costs relative to firm switching costs – degree of differentiation of inputs – presence of substitute inputs – supplier concentration to firm concentration ratio – employee solidarity (e. . labor unions) – threat of forward integration by suppliers relative to the threat of backward integration by firms – cost of inputs relative to selling price of the product – MEDIUM MEDIUM – HIGH MEDIUM LOW HIGH HIGH HIGH HIGH MEDIUM HIGH LOW MEDIUM MEDIUM MEDIUM MEDIUM LOW MEDIUM LOW LOW MEDIUM MEDIUM HIGH HIGH MEDIUM MEDIUM MEDIUM HIGH MEDIUM – MEDIUM 4 3. Estimation of market share of a full capacity CSP plant Total flat sheet segment 36. 6 CSP full capacity 17 Market share of Nucor's CSP plant with 100% capacity 2. 76% Unit: millions of ton 4. CSP plant’s cash flow with assumption: discount rate = 10%, constant cashflow Cashflow per year Total Cost per ton8 8 Revenues per ton Profit per ton Shipment (millions of ton)7 Total Profit per year Hot-rolled (HR) 225 306. 5 81. 5 0. 5 40,750,000. 00 Cold-rolled (CR) 283 390. 5 107. 5 0. 35 37,625,000. 00 Both HR & CR 78,375,000. 00 Cashflow in 10-year opportunity window Discount rate Year Cashflow 10% 0 -340 Unit 1 78. 37 2 78. 37 3 78. 37 4 78. 37 5 78. 37 6 78. 37 7 78. 37 8 78. 37 9 78. 37 $ mil 10 78. 37 NPV IRR Payback period 141. 55 19% 4. 34 $ mil year 6 Exhibit 2 – Steel Mill Product Segments: 1986, page 15 of the case Exhibit 12A – Construction Costs for Flat-Rolled Product Plants: 1986, page 22 of the case 8 Exhibit 12B – Comparative Operating Data for Flat-Rolled Product Plants: 1986, page 22 of the case 7 5 Nucor Case NUCOR CASE In this analysis we use the Net present value to consider if Nucor should invest in the new technology called: thin slab minimill. NPV is really useful in order to make this kind of decision because it uses the concept of future cash value to evaluate whether the investment is worth, however the NPV is sometimes difficult to calculate because it is not always easy to estimate future cash flow.Considering the assumption I made in the first part of the spread sheet, the thin slab project doesn’t appear to be a wise investment for Nucor because the future cash flows at the present value are less than the initial cost of the investment. Comparing the NPV of the three different scenarios it is evident that the best option for Iverson is to continue whit the unmodernized process. The first consideration about to undertake the investment is based on particular assumptions about the future, if we change those the result of the decision could also change.Due to the fluctuati on of the market is difficult to make the right assumptions and this is why to calculate the NPV is not easy. For instance if we changed the discount rate and we lower it below the IRR, the resulting NPV will be positive and this case to invest in the new technology could be a profitable decision. We can also change the steel price rate keeping the cost rate constant, if it is increased enough the NPV could result positive, at the same time if we reduce cost rate keeping the price rate constant we can find an equal result.Regarding the real option analysis if Nucor decides to wait it is unlikely that another will decide to make this kind of investment first. The follow strategy could be a wise decision for Nucor, because the NPV is slightly negative so the management could decide to undertake this investment in order to gain experience and subsequently use that experience for other plants so this initial price could generate future opportunities.