Sims Delivers But Is It Priced In?

This story features SIMS LIMITED. For more info SHARE ANALYSIS: SGM

The company is included in ASX200, ASX300 and ALL-ORDS

By Chris Shaw

One technique often used by analysts to determine whether or not a stock is over, under or fairly priced at a particular point in time is to compare its current price to earnings ratio (P/E) with its historical average. Using such an approach with scrap metal play Sims Group ((SGM)) leads Citi to suggest the stock is overvalued at present, as the stock’s P/E is presently two standard deviations above its historical 12-month forward P/E ratio.

In the broker’s view this means while conditions for the group continue to be positive this is more than factored into the share price at current levels thus making the stock expensive, particularly as it is trading on peak cycle earnings and no peak in profits is being factored into the stock at current levels.

JP Morgan agrees, noting the stock is currently on a P/E of about 18x at present, well above its historical average of 11x.

Citi also sees scope for further margin pressure given the company’s market is becoming increasingly competitive, as reflected by what has been a decline in margins of around 50% since 2004. Having said that the broker did lift its earnings per share (EPS) forecasts by around 3% following the quarterly, which came in 4% better than it expected at $80 million.

The result was right in line with ABN Amro’s forecast so the broker has not changed its numbers much post the report, but it too sees the stock as factoring in too much upside and so it has downgraded its rating to Sell from Hold. Supporting the broker’s view is the scope for foreign exchange rates to impact negatively on earnings, particularly post the Metal Management acquisition.

Deutsche Bank disagrees though, suggesting the fourth quarter result should be strong as Metal Management will make a contribution for the full period rather than for just a couple of weeks as was the case in the third quarter. The broker also takes the view the group’s operating environment has actually become stronger in recent months, and with this expected to continue for some time thanks to a favourable supply/demand outlook Deutsche retains its Buy rating.

Offering further support according to the broker is management’s history of offering conservative guidance, which for the fourth quarter is simply for a result better than for the quarter just completed. Guidance for the March quarter was simply for a result better than the previous two quarters and it came in 40% above the first quarter and a full 80% better than second quarter earnings, lending weight to the broker’s argument.

Deutsche and Merrill Lynch are the only brokers in the FNArena database to place Buy ratings on the stock, compared to one Accumulate courtesy of Aspect Huntley, three Holds and four Sells. The average price target on the stock is $32.23, up from $31.21 prior to the quarterly report.

Deutsche has EPS forecasts for the company of 217c this year and 245c in FY09, while the FNArena database shows average EPS forecasts of 218c this year and 233c next year and Thomson One Analytics has mean EPS forecasts of 212c and 243c respectively and a median price target of $29.75.

Shares in Sims Group today are weaker despite a stronger overall market and as at 12.15pm were down 94c or 2.5% at $37.09, which compares to a trading range over the past year of $23.59 to $38.79.

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