Sims Metal Maintains Its Growth Focus

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

-Acquisitions not main focus
-Leveraged to US cyclical recovery
-Concerns linger over scrap margins
 

By Eva Brocklehurst

Sims Metal Management ((SGM)) is now half way through a five-year initiative to turn around its business. Operations have been streamlined and the primary focus is now on optimising critical components.

Fresh from a site tour of the New York facilities, analysts observe some action on the "optimise" phase, such as tracking profitability with regular supplier analysis and using third parties for lower freight rates. Now for the final "grow" phase. To that end management has reiterated a target of $321m in earnings by FY18 and a commitment to achieving returns on invested capital of over 11%.

JP Morgan remains confident the initiatives can be delivered, given the record to date of resulting benefits surprising to the upside. Both demand and supply sides of the scrap business are challenging, as China continues to be a disruptive force on the global steel industry. The company's ability to compete is limited given billet prices are below scrap in some markets.

Sims Metal believes there is work to be done before actively considering acquisitions. Potential deals will be considered as they come to hand but they are not the main focus. Morgan Stanley expects that should the company not find use for its cash, capital management will likely occur through a share buy-back.

Citi notes the calls for capital management but supports a cautious approach on that front. The broker suspects management is keeping weather eye on potential industry consolidation, given some integrated steel producers, which also trade in scrap, are questioning the long-term economics of their investments.

Nevertheless, the main issue for Sims is the central region of the US, where there is strong competition from domestic participants and volumes have declined 40% over the past year. This compares with more modest falls in the east and west of around 18%.

Sims Metal is considering three options to reduce its losses, including forming partnerships with customers, asset swaps, or re-deploying assets to the more profitable states within the region. Citi observes an opportunity to leverage the east and west operations and feed the central market, given this market only supplies 50% of its own scrap.

The company does not disclose profitability by geography but UBS suspects the central region lost substantial amounts of money in FY15. The company has already idled a shredder in Memphis and closed two additional facilities to restore profitability. Further action is expected in FY16. The stock's main attraction, for UBS, is in the cyclical leverage to a US economic recovery and cash generating capabilities, as well as an un-geared financial position.

Deutsche Bank expects that in the event the company is unable to fix the problems in the central region, it will consider an exit. The new management team is seen reinvigorating the business and now better able to manage and forecast profitability. Most growth is expected to come from electronics and municipal recycling rather than ferrous and non-ferrous metals.

The issue for Credit Suisse remains the margin in scrap prices. Management appears to believe more margin can be extracted from a lower scrap price. Analysis of profitability for every tonne purchased is given as a reason for obtaining higher margins without sacrificing volumes, but the broker is not convinced.

Credit Suisse also points out that some of the bold moves, historically, into new areas with strong market growth and low market share have left a track record of misallocated capital. The broker is also disappointed the formal FY18 earnings target is intact, despite a highly favourable improvement in energy costs and foreign exchange.

FNArena's database has six Buy ratings, one Hold (Credit Suisse) and one Sell (Morgans). The consensus target is $12.08, suggesting 4.9% upside to the last share price. Targets range from $9.70 (Deutsche Bank) to $13.89 (Morgan Stanley).
 

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