Australia | Feb 21 2007
By Chris Shaw
Scrap metal player Sims Group (SGM) reported earnings for the half year of $120m yesterday, which was right in line with previous guidance and so met the market’s expectations. With management indicating ferrous and non-ferrous scrap prices were likely to remain strong into the current half there has been some moves to lift earnings estimates, but for the most part brokers have retained their view the stock is either expensive or a Hold at best.
All except Macquarie and Merrill Lynch that is, the former retaining its Outperform rating and the latter shifting its view from Sell to Buy and setting a price target of $25.00, which compares to the average target according to the FNArena database of $20.72.
Macquarie sees some short-term upside risk to non-ferrous prices, but even allowing for a decline in the longer-term expects prices will remain above their long-term averages. Merrill Lynch is even more positive, suggesting prices in scrap markets could move to a level above their recent highs in coming years as supply dries up on the back of falling exports from the so-called Commonwealth of Independent States or CIS, in effect 11 former Soviet Union Republics which until recently accounted for almost 20% of global scrap metal supply.
The broker notes global scrap metal trade is around 95 million tonnes annually and in 1995 the CIS exported 17 million tonnes, followed by 15 million tonnes last year. By 2008 this is expected to fall to as little as two million tonnes, which suggests a significant tightening in the global scrap metal market.
It is this view that stands the broker in contrast to most in the market, as for example Deutsche Bank expects metal prices to fall significantly in the current half when compared to the December quarter. On its estimates the copper price should decline as much as 17% in the June half compared to the three months to last December 31, while aluminium prices are expected to come down by around 5%.
UBS takes a similar view, agreeing steel price strength should provide a short-term boost for earnings but cautioning prices are likely to decline over the longer-term. As a result, there is no change to its Reduce 2 rating.
While higher than expected metal prices will obviously boost earnings, Merrill Lynch is also impressed by the company’s ongoing acquisition program, which it points out is diversifying earnings. Macquarie agrees, noting the two latest purchases announced this week, which should add around US$13m in EBITDA for an outlay of US$60m, are expected to bring the recycling solutions and non-ferrous segment of company earnings to 36% from 28% a year ago. It notes the company’s balance sheet has scope to fund additional acquisitions.
Adding everything up, Merrill Lynch analysts have set their earnings per share (EPS) estimates at 173c in 2007 and 183c in 2008, before a decline to 169c in 2009. This is in clear contrast to UBS, which is expecting EPS to fall to 149c in 2008 from 172c this year.
Valuations are also behind the divergence in opinion, JP Morgan pointing out the stock is trading at a premium to both its valuation and historical earnings multiple at current levels.
For Merrill Lynch this isn’t a problem, as it expects an expansion in the multiple as the stock is re-rated to reflect this new pricing outlook for scrap and as a result of the upgrades to earnings forecasts this will produce. Its target of $25.00 is based on a prospective multiple of 14x earnings.
Overall the FNArena database shows two Buy ratings and Aspect Huntley at Accumulate, compared to one Hold and six Sell or Reduce recommendations. Sims shares as at 3.30pm were trading 4c higher at $22.14.