Treasure Chest: Sims

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

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts.

By Danielle Ecuyer

Whose Idea Is It? 

Citi

The subject: 

Global metal recycler Sims ((SGM))

More info:

Citi ponders if it is time to reconsider the investment case for Sims and concludes the worst for scrap metal prices appears to be in the rear view mirror, implying owning the shares ahead of operational recovery is worth considering for investors.

The upbeat outlook comes on the back of a downbeat trading update earlier in May at the Macquarie Australian Conference, where Sims management guided to a 2H24 decline in EBIT compared to the 1H24, which marked a significant downgrade to consensus forecasts.

Macquarie lowered earnings forecasts by -170% and -57% for FY24 and FY25, respectively, with the analyst pointing to the adverse impact of China steel exports on the Australian and New Zealand operations.

Goldman Sachs noted the Whyalla furnace had been offline for two months as a contributing factor. Goldman Sachs also flagged severe competition for scrap intake volumes, particularly in US markets.

UBS assessed the Australian and New Zealand markets as the main reason for the guidance downgrades, as well as SA Recycling, the JV with Adams Steel in the USA, which is experiencing trading pressures.

Morgan Stanley also honed in SA Recycling, on the decline in scrap metal intakes and margins over March and April. This business was previously more resilient, so the disappointing update was marked as significant to the analyst.

Citi, however, is not deterred by the early May update and points to the apparent bottoming out in scrap prices, which seems to be taking place as demand dynamics shift to an improved outlook in Sims' major markets.

On a global basis, year-to-date steel production, ex-China is up 1.8% but consumption has expanded 4%, according to the Citi analyst.

US markets might be staging a recovery

Citi's US Metals and Mining analyst highlights a turnaround in the domestic US steel market could be underway. Although weaker demand from a slowdown in warehouse construction and the impact of higher rates has yet to be offset by the re-shoring investment programs and infrastructure development. 

The analyst does note warehouse construction looks to be bottoming out and data centre developments are expected to accelerate.

Looking ahead, the US$100m infrastructure bill is estimated by Citi to add around 3.4mtpa in steel demand, with forecasts electic arc furnace steel production to rise by around 10% (circa 6mt) over the three years until the end of 2026.

Brazilian pig iron is currently US$30/t more expensive than US prime scrap and the analyst anticipates the gap in pricing to narrow.

Citi notes the re-direction of the Sims business to the US domestic market, away from exports, is the main challenge for management.

UBS offers a more positive take on the shift in focus to the domestic North American market. This broker views the change towards higher margins versus volumes will assist in reducing the company's reliance on the softer export markets, such as Turkey.

Goldman Sachs also points to an expected improvement in the North American market. Morgan Stanley emphasised at the time of the early May trading update that management had flagged "positive developments in targeted operational metrics – including increased unprepared scrap and stronger domestic sales volumes".

China: Higher pig iron costs or cheaper scrap metal?

Citi observes the ratio of pig iron to steel production in China has declined to 83% in April this year from 90% at the end of 2023, which is attributed to the price differential between higher input costs (iron ore and met coal) for pig iron versus cheaper scrap metal prices.

The broker details scrap is -US$135/t cheaper than the input costs for pig iron production and expects the percentage to be retained around the lower, more normal April levels. This should underwrite higher scrap prices.

Turkey: Steel production a mixed picture

Jarden issued a cautionary tone on the state of the Turkish scrap metal market recently, highlighting domestic economic issues as a headwind to scrap price increases.

The analyst pointed to the Presidential election and a 44% inflation rate in April for creating uncertainty in the market, as well as the weakness in Turkish lira exchange rate against the US dollar. The Turkish currency has fallen -6% since the start of 2023.

Scrap metal prices have retraced to US$375/t or down -19% from the March peak of US$460/t. The reconstruction estimates in February to March this year for the February earthquake are cited by Jarden as the reason for the scrap price rises. 

Since then, housing construction forecasts have been delayed and government rebar forecasts reduced to 3mt in the next 12-months, down from 4mt.

Jarden observes over the period of scrap price falls the Sims share price has declined -6%, suggesting a correlation to scrap metal prices in Turkey.

Citi has a differing view on the Turkish market and assesses Turkish steel production has risen 22% year-to-date off the November 2022 lows when China had expanded steel exports considerably.

Scrap metal prices reached a cyclical low during this period, Citi points out.

There is scope for a reduction in Chinese exports to EMEA countries as Chinese steel mills are loss-making again and trade sanctions on exports have been trending higher, suggests the analyst.

Citi views the Sims share price is less reactive to the Turkish scrap metal prices than it used to be and highlights an increase in scrap metal imports to 22mt in March from 12.8mt p.a. last September as a positive backdrop for the company.

How do the broker's rank Sims?

Citi retains a $13.50 target price with a Buy rating and is expecting Sims to generate improved margins of EBITDA/t of $59 in line with the historical average by FY26.

With a Neutral rating and $16.60 target price, Jarden believes the sale of non-core assets and a conservative balance sheet should support funding for the volume targets in FY25. Longer term, Jarden expects the company to benefit from decarbonisation and consolidation in the industry.

UBS is also positive on Sims with a Buy rating and a $14.30 target post the 2H24 trading update. This broker anticipates the UK metals business will be sold as part of the strategic review and in doing so there is scope for the sale price to exceed the $243m book value. UBS also believes the company is moving more to its new "margin" focus.

Macquarie has an Outperform rating and a $13 target, down from $16 prior to the 2H24 guidance downgrade.

Morgan Stanley is Underweight alongside a $10 target. This broker concedes the scrap market might be near or at the bottom with green shoots in North America and UK pricing, but Morgan Stanley also considers the 2H24 trading update as implying a challenging near-term outlook, with a lack of transparency and volatility in key markets.

Morgan Stanley also expects progress on the UK asset review, noting Sims management has been flagging "significant interest" in the business.

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