Sims Metal Thwarted By Global Uncertainty

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

Several issues have combined to thwart Sims Metal Management and a substantial downgrade to the first half outlook is the result.

-Further deterioration in the macro economic environment cannot be ruled out
-Trade war reducing demand for steel & aluminium and, in turn, scrap
-Caution prevails around customer scrap purchases for the remainder of FY20
 

By Eva Brocklehurst

Steel mills have significantly reduced their scrap purchases this month and downgraded the outlook for scrap demand. Hence, Sims Metal Management ((SGM)) has materially reduced forecasts for the first half of FY20, stating the result would be "materially lower" versus the first half of FY19.

A rise in deep-sea freight prices has also occurred. Normally, the company would be able to recover these costs through pricing but this is not possible in the current environment. Ord Minnett calculates a reduction in margins for the company of more than -50% is likely.

Forecasts for FY20 are downgraded and the broker suspects the worst half-year performance since the company was loss-making in the first half of FY16 now looms. A recovery before the end of 2019 is considered unlikely and a further deterioration in the macro-economic environment cannot be ruled out.

Challenges

Management highlighted challenges from the US/China trade war, low Turkish steel demand and soft automotive demand at its results, a bare three weeks ago, but had expected to be able to overcome these with strategic execution.

It appears concerns have rapidly been realised and the outlook deteriorated to the point where, as Credit Suisse notes, the company's ability to overcome the issues is swamped by market declines that are beyond its control.

The trade war has reduced demand for steel and aluminium and, in turn, the reduced scrap demand drove the slump in scrap prices over September. The price in the company's key export market, Turkey, is down -16% from the August average and US prices of US$224/t are down -10%.

The company has signalled that scrap prices at these levels are below what is economic for a number of its suppliers to gather and sell, thereby reducing volumes. Macquarie notes, to relieve margin pressures, Sims Metal usually seeks to reduce buying prices but this may be limited by some suppliers choosing to hold inventory until prices recover.

Scrap volume and price reductions are occurring across the entire business and not just isolated to the US. Moreover, US twitch volumes have declined because of reduced automotive demand.

There is no ability to make comparisons with previous periods regarding the earnings contribution between twitch (a higher grade of non-ferrous scrap) and non-ferrous, Credit Suisse asserts, or the volume changes in twitch capacity after the recent non-ferrous upgrades.

Projections Difficult

Projecting earnings for the company is akin to guesswork, the broker laments, and there is material variability in earnings between quarters. The company is reluctant to provide a guidance range, despite its superior market insights, and this compounds the difficulties in forging estimates.

Credit Suisse reduces first half earnings estimates by -50% and leaves the second half unchanged. Citi reduces FY20 estimates by -32% and downgrades to Neutral from Buy. Markets are expected to recover over the medium term, and the broker defers to management's assessment that it is too early to project the impact of issues on the second half.

Macquarie also downgrades, to Underperform, concerned about earnings given the weak global conditions. While the cycle is likely to be heading to a trough, the broker remains cautious around customer scrap purchases for the remainder of FY20.

FNArena's database has one Buy rating (Credit Suisse), two Hold and three Sell. The consensus target is $10.60, suggesting -2.8% downside to the last share price. Targets range from $9.30 (Macquarie) to $12.90 (Credit Suisse).

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