Australia | Nov 11 2021
This story features SIMS LIMITED. For more info SHARE ANALYSIS: SGM
Moves to decarbonise and use cleaner energy across the globe should galvanise Sims as a high-grade processor of scrap
-Strong prices and intake somewhat offset by freight volatility and emerging inflation
-Could a carbon premium emerge for scrap versus pig iron?
-The prospects from decarbonisation key to the medium term outlook as steel markets peak
By Eva Brocklehurst
Sims ((SGM)) is riding a wave of industry trends including decarbonisation and cleaner energy, which have positive implications for scrap usage. Moreover, as countries currently spend money to boost their economies the demand for steel-intensive infrastructure remains high.
The company has guided to underlying first half earnings (EBIT) of $310-350m while scrap intake in the first quarter was up 10%, albeit still below comparable 2019 levels. Strong trading margins in ferrous and non-ferrous scrap in the first quarter were helped by robust pricing.
Citi observes strong market prices and sound margin management across all the company's businesses in the first quarter, which have been partially offset by volatility in freight pricing and emerging inflationary pressures.
North America was the highlight while Australasian margins were affected by weaker sales volumes given the impact of lockdowns. In the UK, margins and tonnage remain strong but affected by closures caused by the pandemic.
There may be a promising outlook for Sims structurally, yet Macquarie warns the risks in the ferrous complex are high, amid moderating prices, energy constraints on output and unreliable trading regimes.
Still, management remains positive about the continued expenditure to stimulate economies, particularly on steel-intensive infrastructure and Macquarie agrees the backdrop is favourable although success depends very much on the company's ability to capitalise on the trends.
Credit Suisse notes global scrap prices have rebounded by 15% to their June highs which is counter to a -4% drop in US steel prices. As a result, the broker increases the margins modelled for Sims in FY22 and upgrades earnings estimates by 9%, pushing out a reversion to the mean to FY24.
The value in securing scrap supply is evident in a number of US transactions, the broker points out, which provides a positive view for Sims. Credit Suisse questions whether a carbon premium for scrap over pig iron could emerge in 5-10 years.
On the broker's calculations: with 1.5t of carbon dioxide emissions avoided for each tonne of scrap used, EUR50/t for carbon would imply a EUR75/t premium and up to $240m in operating earnings (EBITDA) for Sims if it retains its FY21 gross profit margin of 21%.
Morgan Stanley updates ferrous and non-ferrous scrap prices and increases intake estimates while incorporating the acquisition of PSC Metals into SA Recycling and the $150m buyback. As a result estimates for earnings per share increase 27% in FY22 and 13% in FY23.
The broker points out the stock has traded at a -13% discount to the ASX200 industrials ex financials over the past three years and considers a -30% discount in its FY24 estimates appropriate, based on a lack of visibility regarding the earnings outlook.
Morgan Stanley believes steel markets will peak in 2022 and execution on the prospects from decarbonisation is critical to the outlook. UBS is more confident and expects Sims will emerge in front.
The broker asserts Sims is benefiting from its proactive approach as a high-grade processor of scrap material and this will be increasingly important as restrictions on lower-quality scrap imports, such as quality controls in Malaysia and India, are tightened. Restrictions are also likely to increase on scrap exports, with the potential EU waste shipment regulations.
FNArena's database has four Buy ratings and two Hold for Sims. The consensus target is $18.32, suggesting 25.5% upside to the last share price.
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