Global recycling company Sims Metal has announced its net profit after tax for this financial year is expected to fall more 10-15% on the
previous year. Deutsche takes the announcement to mean earnings in FY12 are expected to be at least 30% below FY11. Merrill Lynchhas downgraded the stock to underperform, yet more gloom for the market:
Given the severity of Sims’ earnings downgrade today, and that of peer Schnitzer last week, we now believe there is sufficient evidence to suggest that the ferrous recycling industry in the US is structurally impaired (resulting in constrained margins) for the medium term at least.
- US shredder overcapacity: We see the return to previous peak margins in the key Ferrous Trading business as unlikely in the near term given significant shredder overcapacity.
- Current conditions not too bleak: Despite clearly challenged industry margins, we note that current US scrap volumes and prices do not justify the surprisingly weak result in FY12.
- Consolidation not happening quickly enough: Whilst Sims and other large US recyclers have commented on the requirement for industry consolidation for a number of years, practically we see this as very difficult to achieve given the highly fragmented nature of the market.
Deutsche has a bold buy and a price target of $15.70. But it acknowledges that much depends on improving American profitability:
Leverage to the US recovery exists… how long do we need to wait? 68% of SGM FY12 revenue relates to the US, with only 4% EBIT – highlighting the significant underperformance of the US. Typically, there is about a 6-9 month lag between the US economic recovery and US scrap margins which we think will take place in FY13. Current 2HFY12 US EBIT margins of 0.1% compare to the historic average of 5.5%.
But the stock is on a high earnings multiple of about 20 times and the dividend yield is low. On the fundmanetals there is no cause for joy.