Impressive Stuff From Sims, But Proof Needed

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

– Ambitious 5-year strategy
– Brokers impressed, and acknowledge potential
– Execution success key to re-rate
– Wait and see approach

By Greg Peel

We will hold ourselves personally accountable, said Sims’ recently appointed CEO this week, on behalf of his management team. Bold confidence booster or suicide pact?

Metals recycler Sims Metal Management ((SGM)) saw its share price peak out over $40 in 2008 when the GFC finally brought about the bursting of the Chinese-led commodity price bubble. A rapid collapse to $15 was quickly followed by a bounce back to the high twenties in 2009, but it’s been all downhill ever since to today’s level around $11. A weak global economy and subsequently weak commodity prices, increased global competition and adverse currency movements have all played their part, but at the end of the day, the market came to consider Sims had lost its way.

Until this week. Galdino Claro has only been in the CEO’s chair for nine months but yesterday he left analysts mightily impressed as he clearly articulated what they considered to be a credible five-year recovery plan for the company. The plan will see earnings increase by $240m from the low FY13 benchmark base of $68m by FY18, if successful. Most importantly, the targets set are independent of any macro considerations – hopeful forecasts of a global growth, metal price increases or currency movements do not play any part. Furthermore, not only will management keep the market regularly informed of progress, it will hold itself accountable through incentives.

And, no capital will be expended.

Wow. It’s bold and it’s ambitious, but as far as analysts are concerned, it’s actually quite do-able. The targeted earnings rebound will be driven largely by a turnaround in Sims’ North American and European businesses, which will be delivered through a consolidation of the company’s footprint, the divestment of non-core businesses, better procurement procedures and logistics benefits.

It’s “self-help” plan, based upon three stages: Streamline; Optimise; Grow. “In what can only be characterised as an opaque industry with high earnings volatility,” notes JP Morgan, “management’s decision to present an ‘ambitious but realistic’ plan is undoubtedly bold”. While the CEO’s presentation was light on detail and specifics, the message was clear, suggests Credit Suisse.

With regard to the strategy being “realistic”, Claro revealed Sims had already begun to implement some of the initiatives in a “test region” in North America. The results of that test to date suggest some of the benefits may be realised in the near term, particularly with respect to supply chain and logistics management. Were management able to replicate 50% of the success observed in the test region across all of North America, an estimated $50-60m could be added to group earnings.

It is clear there was always room for improvement. Macquarie was particularly encouraged by Claro’s example of a recycling site which, in July 2013, was being sold unprofitable tons of scrap by over half the 25 suppliers to the site. At that stage Sims did not have the systems and processes capable of recognising it was purchasing scrap at negative margins. The inability to measure and improve scrap sourcing highlights weaknesses in prior systems and processes, Macquarie notes.

Indeed, Macquarie suggests that while industry over-capacity issues remain and that a Sims turnaround is likely to take some time, at this stage the risk is to the upside should the new CEO be successful in delivering even partially on ambitious internal operational improvements. To that end, the broker has upgraded its rating to Outperform, noting further that forecasts have Sims returning to net cash in FY16, allowing scope for false starts during the implementation process.

UBS (Buy) notes Sims has little debt, and will begin to generate significant free cash flow from FY15. This should provide scope to lift returns to shareholders through either a resumption of dividends or a share buyback, and/or other capital management initiatives, if the business can deliver the expected earnings uplift in the next several years.

Deutsche Bank (Buy) believes the initiatives will likely be successful, at least in part, but will not change its current earnings forecasts until some evidence is forthcoming of an impact on the bottom line. Citi (Neutral) applauds the strategy’s clarity and accountability and positive test results to date, but would like to see some clarity and scrutiny around the scalability and sustainability of test initiatives before the broker will “bank the numbers”.

It is worth waiting at this stage, Citi suggests, as execution will be the key to market confidence. But regardless, transparency around strategy execution and the prospect of a longer term market recovery allay some fears.

CIMB is also advocating patience, noting the strategy relies on some “trust me” elements and that trust needs to be earned. The broker believes these elements are achievable, but the macro environment and external factors that Sims’ strategy is independent of remain difficult. CIMB retains Reduce, suggesting there will be limited financial benefit in years one and two of the five-year plan hence the FY14 and first half FY15 results will likely see the stock trade lower, allowing investors with the opportunity to wait before deciding whether Sims’ plan can be successfully implemented.

The split of broker views between a “can’t hurt” approach and a “best wait and see” approach is evident in a hesitancy for all to incorporate any earnings forecast upgrades at this stage, particularly with the official FY14 result due next month. It is also evident in an even split of four Buy or equivalent ratings in the FNArena database against two Hold and two Sell.

Some benefit of the doubt is at least evident in the database consensus target, which has risen to $11.31 from $11.01, ranging individually from $10.00 (CIMB and Credit Suisse, both on Sell) to $12.30 (JP Morgan, Buy).

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