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Sims Shines In The Scrap Yard

Australia | Feb 16 2022

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

A forecast-beating result from Sims, a dividend increase, and a positive industry outlook had brokers racing to upgrade earnings estimates.

-Healthy increases in volumes and prices for Sims
-Outlook remains positive
-Decarbonisation a longer term driver
-ESG winner

By Greg Peel

In the face of freight, inflation, and covid disruption pressures, scrap merchant Sims ((SGM)) surprised the market with solid cost controls, leading to a beat of broker forecasts and the company’s own guidance in the first half.

Intake volumes of ferrous and non-ferrous scrap were up 12.8% year on year in the period to reach 96% of the FY19 (pre-covid) monthly average – so still not quite there – yet Sims’ earnings (EBIT) of $362m were six times that of the first half last year.

The interim dividend of 41cps surprised some brokers, up from 12cps a year ago. And a $54m share buyback was announced, together implying a 50% payout ratio.

Cash conversion nonetheless fell well short of expectation, but this was due to a working capital build-up due to higher scrap prices, so net-net not an issue. Full-year capex expectations were lowered by management by -$50m, but this is due to a lower allocation to Sims Resource Renewal on a decision to pause the construction of the Campbellfield (Victoria) facility.

Average sales prices in the half were up 64% for ferrous and 46% for non-ferrous scrap year on year. Add in the 12.8% increase in total volumes, and subsequent increased revenues were able to offset higher increased operating costs due to inflation and other factors. By keeping a lid on the costs it could control, Sims was able to beat on earnings.

The Outlook

Management did not provide quantitative FY guidance, but noted buoyant market conditions are continuing into the second half.

Brokers expect ferrous prices to remain largely stable at current levels in the second half, but see continued strength in non-ferrous prices. Continued volume growth is key, suggests UBS, noting volumes are still shy of pre-pandemic levels, which points to upside potential.

Volume growth will also be supported by recent bolt-on acquisitions, which should also help to drive operating leverage in the long term, UBS suggests.

Management has also indicated that freight pressures are being managed, and efficiency gains are being sought to offset inflationary pressures.

Brokers agree Sims will benefit from the global shift towards decarbonisation of manufacturing and the increasing use of electric arc furnace production in the steel industry. China’s push towards emissions reduction is gathering momentum, Ord Minnett notes, implying greater demand for scrap as an input.

In short, Sims ticks all the ESG boxes.

Sourcing material should not be an issue as governments look to infrastructure spending as providing economic support in a post-covid world. Australia is among those with grand infrastructure plans, but the US tops the bill with Biden’s extensive intentions actually passing through Congress.

The more structures that are knocked down and rebuilt, the more scrap.

Passing the Peak?

Despite the outlook, brokers do not believe such glory days for Sims will continue forever, and indeed FY22 may see a peak. But this is not to say it’s all downhill from there, just a fading of strong earnings margins over time.

This does not deter five of six covering brokers in the FNArena database retaining the Buy or equivalent ratings they held pre-result.

Macquarie points out Sims is trading at a -52% price/earnings discount to the ASX200 Industrials versus a ten-year average premium of 9%.

There are also risks of course – covid, rising interest rates, geopolitical issues, slowing economies, but FNArena brokers have lifted their consensus target price to $19.32 to $18.83, which still implies 11% upside despite yesterday’s 13.7% share price pop on result.

Despite the pop, the stock continues to look inexpensive on price to net present value, enterprise value to earnings, and a growing cash position, Ord Minnett declares.

A 4.3% forecast FY22 dividend yield is not to be sniffed at either, albeit offshore activity restricts franking to 44%.

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