Metal stocks round-up

Sims Group, for example, is up 56% since issue 99/Mar 02 (Buy for Yield - $6.93). But, instead of rejoicing, we're scared stiff. Such price rises, especially in a stock recommended for income, provoke scepticism rather than delight. And, boy, are we sceptical.

Booming forever

For a moment, though, let's entertain the idea that Asian economies are inoculated against the boom-bust cycles of the West and that Chinese demand is insatiable now and forever more. Let's imagine that this time, it really is different.

For the last few decades the Chinese government has presided over an economy growing at more than 8% a year by following policies that are the very antithesis of those prescribed elsewhere: state ownership, central planning, restricted markets. Will it be happy to rely on foreign companies for the provision of its most basic materials? We doubt it.

As in Japan's postwar boom, it's more likely that everything that can be manufactured at home will be. And that which has to be imported will be, too, until such time that domestic production is increased to meet demand.

Now, if this boom continues in perpetuity (which of course it won't), the likes of BHP Billiton and Rio Tinto would enjoy a bonanza. Both sit atop huge supplies of iron ore and other essential raw materials that aren't abundant in China. But further down the line, for the metal manufacturers, it's a dangerous trap.

Whilst the like of OneSteel, Smorgon Steel and BHP Steel, (soon to be BlueScope Steel) are ramping up production, so too are the Chinese. And we're not just dreaming this up. China's State Development and Reform Commission recently released a report stating that a 'huge amount of steel-making capacity was to come into production in the next three years'. And the situation is bound to be similar in metals like aluminium.

It's part of the reason why our views on all the steel manufacturers have been negative for some time, as the table below shows. But what of metal recycler Sims Group?

To be sure, the group's latest result, with dividends up a whopping 50% to 54 cents, was exceptional. And that's the key word: in our view this performance is unsustainable - the last year, we suspect, will prove to be an exception. Sims' recent results, and those of the steel stocks can, to a large degree, be explained by the fact that China's recent economic growth has outpaced its ability to build new metal manufacturing facilities. It's been importing so much that world metal prices have risen.

Overpriced

But we firmly believe that this boom will last only as long as it takes for the Chinese to build new production plants – a few years at best. Then ferrous and non-ferrous metal prices will fall, if demand doesn't slow beforehand. Either way, Sims and every other metal stock will be affected.

Now, we can't say when that might be but this stock is trading at a 153% premium to its net assets of $4.28 a share. After deducting intangibles like brand names, its net tangible assets are only $3.57 a share, 76 cents of which is cash (which we'd rather was burning a hole in our pockets than Sims'). It's truly frightening.

Perhaps some of the company's assets aren't easily replicated but its output sure is, as China, now the world's largest steel manufacturer, is clearly proving. Why on earth would anyone pay $3.03 to get $1 worth of Sims' existing production assets when the Chinese can pay a dollar for much the same thing? Sims isn't that good a stock.

The stock is up 2% since issue 136/Sep 03 (Take Part Profits - $10.60) and we recommend subscribers go one step further and offload their entire holding. SELL. Exactly the same argument applies to the three major listed steel stocks. We've had Sells on each for a while now, but our growing concerns with a new strain of The China Syndrome make it worthwhile restating that view. SELL.