Recycling Sims

Until the outbreak of the global financial crisis Sims Metal Management could do no wrong. After that, it could do no right as its shares plunged from more than $40 in mid-2008 to less than $8 in August last year.

But recovery is underway, and Sims has become a stock to buy as consumer confidence returns, and old cars and household appliances are replaced, providing the company with a growing supply of its essential raw material, scrap metal.

Once described as an “above ground miner”, Sims is a unique Australian-based company because of its strong exposure to the US economy. This is where it generates more than 60% of its sales, and while it has just reported a second consecutive tough 12-months of trading, the outlook is up – as is the share price. It rose by more than 80 cents (9%) last week to $9.84, although the sharp drop in the overall market today saw its price taken back to $9.54.

As well as watching its future potential supply of raw material grow through the replacement of cars and appliances, Sims should also benefit from a steady recovery in mineral and metal prices which flow into the scrap market.

Dividends, which were dropped earlier this year after a horror run of poor results in the US and Europe, and a series of incidents including allegations of fraud in its British business unit, are likely to be restored next year as profits replace losses.

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Some investment bank analysts have started to change their negative opinion of Sims, which had been tarred with widespread sell recommendations. The company has been forced to digest losses totalling more than $1 billion as a result of intense competition for a declining flow of scrap metal, which severely compressed profit margins and crush asset values.

The weak trading conditions caused Sims, which claims to be the world’s biggest metal recycler, to report statutory losses of $623 million in financial 2012, and $469 million in the year which ended on June 30.

Asset impairment charges accounted for a large share of the losses, with a modest underlying profit posted in the latest year, while pre-tax earnings came in at $67.9 million, and after-tax earnings at $17.1 million.

Further internal uncertainty at Sims has been created by the retirement of the chief executive, Daniel Dienst, on July 1, with a replacement not expected to be chosen until early 2014.

Most of the bad news is now in the market, with a number of positive indicators pointing to the worst being over in the scrap business. These include a rise in US consumer confidence, increasing light vehicle sales, and a boost in shipments of household appliances – three key generators of scrap metal.

In a management discussion attached to the latest loss report Sims noted that ferrous (iron and steel) scrap, which makes up close to 50% of the company’s business, was improving in the east coast US market. A $US30/tonne rise in July was followed by another $US10/t increase in the first two weeks of August.

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“Underlying fundamentals for scrap generation have shown a steady improvement in the US,” Sims said. “Consumer confidence, a key leading indicator for consumer scrap creation, reached a five-year high in June.

“Correspondingly, auto and major household appliance sales have also increased. New auto sales in the US reached an annualised rate of 15.9 million vehicles in June, up 10% year-over-year. As well, US manufacturer’s shipments of major appliances were up 7%.

“While the company has yet to see a significant change in the scrap intake thus far in financial 2014, the broader macro trend in North America is encouraging.”

The importance of the US and Canadian markets to Sims is evident in the sales breakdown, with 63% recorded in North America, 21.9% in Europe and only 15.1% in Australia and New Zealand. To complement its US exposure, the company also maintains a listing on the New York Stock Exchange.

Overall group sales, which fell 20.4% last year to $7.2 billion, are forecast to recover to around $8.5 billion in the current financial year, and then up again next year to around $9.3 billion.

Losses over the past two years are forecast to be replaced by a pre-tax profit this year of around $124 million, with the dividend restored at 25c a share. As well as improving scrap metal margins Sims has been cutting costs, removing 279 employees from its payroll last year.

Not everyone is convinced that Sims is out of the woods, though the trend among investment bank analysts is positive.

Macquarie Equities, CIMB Securities and Credit Suisse are among the doubters who believe Sims needs to deliver more proof of a sustainable recovery. Macquarie rates the stock as underperform, CIMB has downgraded Sims from outperform to neutral, and Credit Suisse is sticking with a neutral rating.

JP Morgan, UBS, Deutsche Bank, BA Merrill Lynch and Goldman Sachs rate Sims a buy, despite what they universally described as a poor result for financial 2013.

UBS described Sims as a “late cycle play on North American housing and consumer recovery over the next few years” while also noting the company’s strong cash position.

Goldman Sachs downgraded its future earnings forecasts for the stock to reflect ongoing tough trading conditions but maintained a buy tip on Sims.

“Clearly conditions remain challenging for Sims,” Goldman Sachs said in a note sent to clients after the company reported last Friday. “However, the key attraction of the stock, in our view, is that it remains leveraged to a recovery in the US economy.”

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