Accelerating Demand For Scrap Drives Sims

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

Rising scrap prices and a sharp increase in volumes have allowed Sims to deliver FY21 earnings guidance way ahead of expectations

-Brokers looking for signs of a structrual shift in demand
-Global stimulus driving scrap demand
-Outlook for low-emissions steel key to scrap longer term
 

By Eva Brocklehurst

Times are good for scrap metal handlers and Sims ((SGM)) is no exception, guiding to FY21 earnings way ahead of expectations. March quarter intake was back to 95% of FY19 average monthly volumes and there has been a general improvement in gross margins per tonne.

Scrap prices rose in all markets in which the company participates. Prices for both ferrous and non-ferrous are above FY18-19 levels and UBS is not surprised that margins have expanded to $60/t today from $30-35/t back then.

The company expects FY21 earnings (EBIT) of $260-310m, with the mid point 70% above Ord Minnett's forecasts and causing Macquarie to upgrade FY21 estimates for earnings per share by 83%. Cost savings are also ahead of budget, with $70m of cost reductions along with disciplined buying underpinning the improvement.

Guidance far surpassed Credit Suisse's estimates too. The broker assesses the second half should be the highest earnings half-year period for more than a decade, surpassed only by the second half of 2008 when EBIT was $511m and ferrous scrap prices exceeded US$700/t.

In this context, Credit Suisse notes current spot pricing for ferrous is US$430/t, so not that high. What has been considerable, nonetheless, is the speed and magnitude of the increase in ferrous scrap prices.

The broker concludes a material portion of Sims' earnings can be attributed to the inventory cycle, in which the company acquires lower-priced scrap that is transferred for sale into a higher priced market, generating expanded margins.

Morgan Stanley does not extrapolate this significant upgrade to earnings expectations and would become even more positive on further evidence the current strength in scrap is a result of structural shifts in demand rather than short-term cyclical factors.

The broker notes disruptions from the pandemic and a potential moderation of steel prices could exert pressure, although expects ongoing earnings momentum will continue to support the stock. While earnings are robust, Citi expects a normalisation over the next 18 months to more sustainable levels, forecasting around $226m and $189m in EBIT for FY22 and FY23, respectively.

Margins

Credit Suisse does not believe current margins are sustainable and cautions that a repeat cannot be expected from the second half although, from a broader view, expects global fiscal and monetary stimulus will continue to drive scrap consumption.

UBS assesses that the improvement is coming from margins rather than volumes, driven by higher prices and inventory gains, as the average price of acquired scrap is lower against the time a whole cargo is sold (cyclical factors). The broker forecasts FY22 EBIT margins of $41/t compared with $40/t in FY21.

UBS is also on the lookout for new US electric arc furnace capacity that will drive higher demand for scrap and also news that China is importing more ferrous scrap as it slowly moves towards higher scrap usage in blast furnaces in order to reduce emissions.

Green Steel

Morgan Stanley points out markets are tight and emissions control measures in Tangshan have potential to increase demand for ferrous scrap and tighten the market further. Chinese initiatives regarding emissions reductions is a development the broker will be watching closely.

Ord Minnett remains attracted to the scrap markets because of the potential as raw material for low-emissions steel, signalling a positive environmental backdrop, and there is a potential for China's imports to increase and underpin prices. Yet the low earnings visibility and recent bounce in the share price suggests the upside is now incorporated into the outlook for Sims.

On the other hand, UBS argues that upside from a shift towards more scrap-intensive steelmaking over the long-term is not reflected in the price of the stock. The share price has doubled since October, when expectations about China's re-opening helped accelerate scrap prices.

Further consistency from the company's updates as well as the increasingly positive environmental thesis stemming from 'green steel' should stimulate investor interest, in the broker's view.

Still, UBS warns that Sims remains a cyclical business and global trade disputes can mean scrap markets freeze, leading to poor margins. Also, margins are likely to decrease over time as competition from established operators intensifies.

UBS also highlights cloud recycling is becoming a higher-value stream within e-cycling and Sims is looking to grow volumes in this area to 200,000t by FY25 from just 20,000t in FY20. FNArena's database has two Buy ratings and four Hold for Sims. The consensus target is $17.47, suggesting 5.9% upside to the last share price.

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