BUY HOLD SELL – Sims Ltd (ASX: SGM)
Sims Ltd (SGM) was one of the best performers of the February results season, currently up more than 24% since reporting half-year numbers.
SGM is a metals and electronics recycling company that focuses on ferrous and non-ferrous metals recycling (for those who can’t remember their chemistry, ferrous means ‘with iron’), post-consumer electronic goods recycling, and waste recycling. Its mission statement is one that would make you proud to be a shareholder – A world without waste to preserve our planet. A good slogan to fuel the ESG funnel.
Underlying EBIT of $361.7m came in significantly above guidance of $310-350m and consensus of $335m. The stock was up more than 13% on the release. Strong cash flow and buoyant prices for ferrous and non-ferrous metals were the tailwinds. Speculation about a $100-150m buyback in FY23 and a higher dividend talked up by media. A 41c interim dividend was declared plus a $54m on-market share buyback.
Despite the positive reception from the market, two issues emerged from the strong update; one was the higher costs from operations. The second was the delay of the Sims Lifecycle Services (SLS) business due to semiconductor issues. Now, postponement in SLS could even be manipulated as a positive given the build-up in demand but higher costs are more of an issue, there was a suggestion that it could be part of the ‘new normal’ going forward. Transitory or persistent? Maybe we should ask the Fed. Hard to say from this standpoint if they will be sustained but it would be prudent to keep an eye out for margin pressure and higher operating costs regardless. Sims said it is managing the volatility in freight costs (which are still near record highs) and actively seeking efficiency gains to offset inflation. To its credit, SGM’s trading margin increased in the half.
On the outlook, management said momentum is continuing into the second half, intake levels are solid and demand for ferrous and non-ferrous products remains robust. Not surprising given the spike in base metal prices on the back of geopolitical tensions.
- ROE of 21% is solid but the outlook isn’t appealing, expected to drop to 9.3% in the next few periods.
- A PE of 7.7x looks cheap on initial inspection but peer in BSL sits on 3.9x so it is more expensive than you think vs a peer comparison.
- A gross yield of 5.1% is strong and ahead of BSL which has a yield of only 2.5%.
- It is trading at a more than 5% discount to the average broker target price surveyed by Reuters.
- Market cap of more than $3.5bn.
- Net debt of $317m. Positive net debt means Sims has more debt on its balance sheet than cash. An important metric to look out for especially with higher rates on the horizon.
- SGM’s had ~$240m in cash on its balance sheet at the end of the calendar year.
What sort of investment is SGM?
The majority of Sims earnings comes from its Metals and SA Recycling segments which are benefiting from several macro tailwinds:
- Scrap metal prices have been very buoyant as the steel industry shifts to using more scrap. The average selling price increased 72.2% in the December half, compared with the same period a year earlier.
- The global steel industry makes up ~8% of the world’s carbon emissions. That number is likely to be much lower in the next few years with legislation domestically and abroad looking to cut emissions in the industry with a focus on decarbonisation. ~27% of steel capacity is already covered by a corporate net-zero target.
- Strong infrastructure spending. The federal government recently named “green steel” as one of six technology areas that will help Australia reach net zero emissions by 2050. The Chinese government also ramping up infrastructure spending to stimulate the slowing Chinese economy.
- The fundamental drivers of the cloud infrastructure recycling environment also remain positive over the medium term. A reference to its SLS segment which focuses on IT asset and cloud infrastructure reuse, redeployment and recycling.
- Geopolitical tensions in Turkey are one area of concern as it is a key market for SGM according to Macquarie. Turkey like other European countries depend on Russia for natural gas and an energy crisis could materially affect scrap demand. For how long that could last or how severe it could be remains unclear. Europe gets nearly 40% of its natural gas and 25% of its oil from Russia and Sims gets ~18% of its revenue from its Europe Metals segment. Media reports have speculated that sanctions could last months and possibly years. For some colour, 51% of its revenue comes from its North American segment with Australia and NZ accounting for only 17%.
On the strategy side of things, SGM is looking solid. Progress on its FY25 targets which are shown below and strengthening the market position of its main profit drivers SA Recycling and Metal segments through acquisitions pleasing highlights.
Macquarie said OUTPERFORM after results came in ahead of estimates. Sees SGM well positioned in the decarbonisation of global metal production, both ferrous and non-ferrous. Citi said BUY following results which outpaced forecasts. UBS said BUY and sees continued strength in non-ferrous prices and largely stable ferrous prices on the horizon. While this supports Sims’ earnings outlook, UBS maintains continued volume growth is key. Credit Suisse said OUTPERFORM, noted strong prices were largely offset by higher operating costs.
One of the best performers this results season, up ~13% on the day and more than 30% higher in the last 12 months. Not exactly a BL2TR (bottom left to top right) performer. The stock recently topped out just short of 1900c, currently finding some support at the 1800c level. RSI touched overbought territory but has come back. Not the most attractive chart.
A lot more blue than red in the top shareholders list. BlackRock bought more than 3.3m shares back in January. The top two shareholders Mitsui and Allan Gray Australia own ~one third of the company. Institutional attraction arguably improving on SGM’s position in the ESG space.
Short interest of little concern. Has been tracking lower and lower since a 10% high back in July 2019. Currently at a modest 2%.