Australia | Aug 30 2011
– Sims result better than expected
– Stock continues to offer leverage to a US recovery
– Acquisitions could also drive growth
– Ratings upgraded, stockbrokers now all rate Sims a Buy
By Chris Shaw
Scrap metal group Sims Metal Management ((SGM)) beat market expectations for full year earnings, underlying net profit of $182 million about 15% ahead of forecasts even after the strong Australian dollar impacted on earnings by around 10%.
Driving the better than expected result was the Ferrous scrap trading business, which was helped by a strong lift in American scrap intake and volumes. According to UBS, US scrap prices were also better than forecast, thanks in part to increased demand from Korea and a stabilising of Turkish demand.
This demand side improvement sees UBS suggest prices for scrap should be relatively stable in the September quarter relative to the June quarter, before stronger prices flow through in the three months to the end of December.
The price outlook is important for Sims, as Credit Suisse notes June quarter earnings of $69.3 million were quite strong relative to previous quarters. The half-yearly earnings splits highlight this as profit in the first half was only around $49 million, indicating a much stronger second half.
Along with better prices, Credit Suisse sees operational leverage as a likely positive for Sims, as management has indicated around two million tonnes of volume remains to be restored to the US market.
As volumes recover Credit Suisse expects higher margins will follow, so driving earnings. As well, new growth should come from the Recycling Services division and from further bolt-on acquisitions. Funding such acquisitions should be more comfortable as strong cash flow and inventory liquidation has seen net debt to fall to $126 million as at the end of FY11. This compares to a level of $381 million as at March 30 this year.
To reflect the full year result, stockbrokers have revised earnings estimates in the market but the revisions have not been uniform in size or direction. While Credit Suisse has lifted its numbers by 0.2% for FY12 and by 7% for FY13, both Goldman Sachs and UBS have trimmed their numbers across both years.
The changes mean consensus earnings per share forecasts for Sims according to the FNArena database now stand at 134.2c for FY12 and 157.2c for FY13, which compares to the less than 100c per share achieved in FY11.
Changes to earnings forecasts trigger changes to price targets and again the adjustments have gone both ways, JP Morgan lifting its target by 60c to $22.30 but UBS trimming its target to $18.57 from $19.50. The consensus price target according to the database now stands at $19.81 against $19.72 prior to the result.
Credit Suisse, Deutsche Bank and UBS have all upgraded to Buy ratings on Sims from Hold previously following the profit result, bringing total ratings to a perfect seven-for-seven Buy recommendations. Goldman Sachs is not in the database but also rates Sims as a Buy with a target of $22.31.
What justifies a positive view, according to UBS, is Sims offers a good risk adjusted US dollar and US economic recovery play and these recovering earnings are not currently being priced in to the share price by the market.
UBS accepts the US recovery may be more subdued than some in the market had previously forecast, but to counter this the broker notes the strength of the Sims balance sheet means flexibility for M&A activity to boost earnings. Deutsche Bank agrees, estimating Sims could spend up to $900 million on acquisitions via debt funding and still remain within management's target gearing range of 15-25%.
The balance sheet strength also offers scope for capital management or, as JP Morgan points out, further investment in newer technologies that will stand the company in good stead as market conditions turn more favourable.
There is also value at current levels according to Credit Suisse, as its 12-month price target of $19.00 implies a FY12 earnings multiple of 14 times on what are depressed recovery earnings. BA Merrill Lynch is similarly positive on the valuation story, noting with scrap volumes still a long way below the peak levels of 2008 there is plenty of upside potential for earnings going forward.
Shares in Sims have traded a range over the past year of $13.36 to $22.36. The current share price implies upside of around 28% to the consensus price target in the FNArena database.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
