Australia | Sep 18 2007
By Greg Peel
With a B/H/S ratio of 3/3/4, scrap metal specialist Sims Group (SGM) is one of those stocks that has been polarising analysts this past year. While there is little disagreement ferrous scrap demand will remain solid, the debate is all about whether this will only increase competition and force down prices.
The market has clearly been very positive on the stock, however, as the share price has soared from a credit crunch bottom last month at $24 to a substantial new high of $34. Prior to August, Sims’ high price was $28. As rallies of this magnitude trigger attention from the ASX, Sims has been asked to please explain why the significant rise. Instead of the shoulder shrug that so often follows from such ASX requests, Sims has responded by lowering its first quarter guidance. This took some of the wind out of the share price sails yesterday.
Management has reduced its first quarter (ends October) profit guidance to “less than $60m” from “less than $68m”. The reasons given were a trading update and currency adjustments. This came as little surprise to analysts, as they had been expecting a weaker quarter anyway. The recent surge in scrap metal prices – the reason why the market has chased the stock – will not flow through until the second quarter figures. For this reason, Sims highlighted that Q2 will provide a better result.
But management also added higher ferrous prices are being offset by “intensive buy price competition”, as well as higher freight rates. Ah hah! say the bears. This is exactly where the argument lies.
The two Buy recommendations – Macquarie and Deutsche – both see prices remaining strong despite conceding competition. Interestingly however, their target prices of $32.00 and $31.50 respectively are both below yesterday’s close, and well below the recent high. Deutsche even upgraded its target from $30.00 to $31.50 this morning.
By contrast, UBS (Sell) has set a target of a mere $23.70. UBS has been most vocal in arguing the market is ignoring the potential for volatility in scrap prices, and the ease of which competition can move in and spoil the party. That’s before you even start talking about freight rates. Both Merrill Lynch (Neutral) and GSJB Were (Sell) expect the shares to be sold down further following this downgrade, with Merrills suggesting a $25-30 range is more appropriate and Weres setting a target of $25.97. JP Morgan (Underweight) is actually bullish scrap metal prices, but simply believes the stock is overvalued (target $25.70).
JP Morgan also sees the potential for Sims to make acquisitions, as does Macquarie, but Merrills does not want to get too excited. Assets are overpriced at present, and the analysts see any acquisitions as being scrip-swap joint ventures with incremental benefits, rather than big cash outlays. Merrills also notes that Mitsui holds 19.9% of the shares, and the Japanese are not keen on hostile takeovers. Hence Mitsui is unlikely to bid for the rest of Sims, and anyone else looking to have a swing would probably be blocked by the Japanese stakeholder.
With the share price closing at $32.10 yesterday the average target now stands at $27.11 – 15% lower.