Sims Metal Turning Waste To Energy

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Sims Metal has highlighted the increased value of the material in waste streams, flagging a significant diversification from its core scrap metal business.

-New initiatives to exploit fast-rising energy and landfill costs
-Australia to provide demonstration plant and the US to follow
-Capital expenditure expected to diminish cash returns
 

By Eva Brocklehurst

Sims Metal Management ((SGM)) has hailed the future with a significant change in strategy, intending to harness the energy from combustible waste material and roll out an expanded version of its Australian landfill gas capture and energy business.

The company has highlighted the increased value of the material in waste streams and, while its scrap metal business remains core, around 5% growth per annum over the next five years is envisaged through acquisitions, greenfield sites/plants and organic growth.

The main opportunity, the company has flagged, is the waste-to-energy business, which recognises the already-high and rising cost of landfill waste, particularly in Australia and the UK.

New business being developed is in the waste-to-energy segment, as well as the offshore expansion of existing landfill gas capabilities. The company considers the best waste-to-energy implementations are in Australia and the US. The first site for this gasification of waste is planned for Australia, co-located with the processing facility and operational in 2022. The expected capital cost is $158m over five years.

Landfill costs to the company are $103m globally, of which 75% is calculated to be able to be diverted to energy generation. Australia has punitive energy and landfill costs but lacks the scale of the company's US operations and offers very limited volume growth. However, Australia will provide the demonstration plant and the US will follow, with larger-scale opportunities.

In its traditional business, Sims Metal has outlined plans to increase North American ferrous volumes by 40% and double non-ferrous volumes to 300,000tpa. The key components include the acquisition of 25 feeding yards, bolt-on acquisitions and market growth.

To Deutsche Bank the 15% internal rate of return target is pleasing but the transforming elements of the new strategy are unlikely to be providing significant upside until after FY25.

Growth expenditure of around $670m will also be required from FY20-24. The broker is confident US volume growth will arrive but remains conservative about the outcome for the energy part of the business.

Landfill Usage

Sims Metal is already established as a landfill energy producer, with a landfill and solar energy project which it holds in a 50-50 joint venture with LMS Energy. Credit Suisse points out that LMS Energy has been a largely undisclosed and undiscussed asset in the company's portfolio to date, but as of today it has been elevated as a growth opportunity of significance.

The other prong to the strategy is taking e-recycling to a new level. The opportunity identified is around 6MTR of data centre server material currently installed to service the cloud, of which 2mtpa of recyclable and reusable material will be released. A US market share of 10% is targeted by FY25.

Management believes this is a high margin opportunity but Credit Suisse notes previous investments in such recycling have materially fallen short of expectations. In sum, the broker finds positive aspects in the fact the new growth is staged and conditional on the success and early returns from initial investments that will test and demonstrate the concepts. Morgan Stanley suspects competition, particularly in cloud materials recycling, is likely to be robust.

The company expects to roll out seven sites for its waste-to-energy business over the next 10 years on a case-by-case basis. Over the next five years two operating plants are being targeted with a further two more in development.

UBS suggests that permits and environmental oversight pose the greatest risk to the company's timeframe. Ord Minnett also envisages some risk that capital from outside the industry could disrupt the waste management value chain, albeit mainly in the municipal channel.

The broker, nevertheless, believes the waste management industry is the best positioned to generate returns from waste-to-energy. Morgan Stanley would like to observe the proving up of the opportunity and suspects the timeframes may prove ambitious but agrees minimising waste stream and generating revenue make sense.

Capex Versus Cash Returns

The negative aspect for shareholders is that the company is reclaiming its balance sheet and taking on new risk, rather than returning cash. Credit Suisse also warns dividend franking is now largely depleted and future dividends will only be paid where they can be 100% franked, so will be constrained by Australian earnings.

Also, almost all growth appears to be from offshore initiatives. Morgan Stanley agrees the likelihood of meaningful capital management is reduced over the next five years and a desire to only pay franked dividends has potential to reduce current dividend expectations.

China

UBS suggests the decision to leverage the growing focus on recycling is positive but long dated, and coincides with a time when China continues to disrupt non-ferrous scrap markets. Hence, the broker remains cautious, as China now requires importers of category 6 scrap to have quotas after July 1.

Citi believes the company's newly-commissioned Zorba separation plant is well timed. The high-quality, furnace-ready products has potential to avoid China's import restrictions. Scrap imports to China have been declining because of tightening quality standards on the type of material the country was prepared to accept.

The company believes, as Chinese demand for recycled scrap continues to grow, the most likely scenario is for materials to be increasingly processed in alternative markets before shipping to China. Hence, Citi suggests the new Zorba plant may provide a solution. The plant converts around 80% purity non-ferrous scrap into furnace-ready products such as copper, aluminium and stainless scrap.

FNArena's database shows four Buy ratings, two Hold and one Sell (UBS). The consensus target is $12.03, suggesting 11.9% upside to the last share price. Targets range from $9.10 (UBS) to $14.00 (Macquarie, yet to comment on the strategy).

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