World dom­i­na­tion in less than a cen­tury

The Weekend Australian - Review - - Investments - James Dunn

SIMS Group is a mem­ber of that rare group of Aus­tralian com­pa­nies that have rid­den glob­al­i­sa­tion to the peak of their par­tic­u­lar busi­ness. A se­ries of merg­ers over re­cent years has made Sims, which was founded by Al­bert Sims in Syd­ney in 1917, the world’s largest scrap metal re­cy­cler.

Each year Sims Group feeds the equiv­a­lent of more than 100 Syd­ney Har­bour Bridges into its shred­ders on four con­ti­nents — and that’s just metal.

Sims re­cy­cles met­als such as steel, alu­minium, cop­per, ferro- al­loys, lead, zinc, tin, an­ti­mony and sil­i­con; and plas­tics, salt, tyres and e- waste’’ — the term for re­dun­dant com­puter equip­ment, TVs, mo­bile phones and all other elec­tronic ma­te­rial.

The com­pany’s com­modi­ties trad­ing arm dis­trib­utes a wide range of semi- fin­ished raw ma­te­rial prod­ucts, through the Sims Metal net­work, to a variety of in­dus­tries. Sims also has a 50 per cent in­ter­est in LMS Gen­er­a­tion, a spe­cial­ist Aus­tralian land­fill gas and power gen­er­a­tion com­pany that gen­er­ates more than 150,000 megawatt hours ( MWh) of power a year from 10 sites around Aus­tralia.

Through a joint ven­ture with Aus­tralian waste and lo­gis­tics provider Collex ( a busi­ness unit of the world­wide Ve­o­lia En­vi­ron­nement Group, it­self a world leader in en­vi­ron­men­tal ser­vices, Sims has be­come the world’s largest re­cy­cler of e- waste.

The ex­tent to which Sims has be­come a global leader is starkly shown by the fact that it is no longer based in Aus­tralia. Since its $ 1.9 bil­lion merger with US ri­val Metal Man­age­ment last year, Sims has moved its head of­fice to New York and Metal Man­age­ment’s chief ex­ec­u­tive Daniel Dienst has taken charge of the com­bined en­tity. For­mer chief ex­ec­u­tive Jeremy Sut­cliffe now runs the com­pany’s non- US op­er­a­tions.

But in case that looks like a takeover of Sims by Metal Man­age­ment, Sims share­hold­ers own 70 per cent of the merged en­tity. Sut­cliffe says the move to New York — and his ap­par­ent de­mo­tion — re­flects the re­al­i­ties of where Sims is go­ing in terms of its in­ter­na­tional ex­pan­sion’’. Be­cause Sims de­rives 62 per cent of its earn­ings in the US, he says, the com­pany needs a chief ex­ec­u­tive in the same time zone as its main area of op­er­a­tion.

By Sims’s own cal­cu­la­tions, the merger cre­ates the world’s largest re­cy­cler, pro­cess­ing and trad­ing more than 15 mil­lion tonnes of metal a year.

Sims has reached its top- dog sta­tus in scrap metal through a strat­egy to lead the con­sol­i­da­tion of the in­dus­try. Since 2005 Sims has merged with New York- based scrap pro­ducer Hugo Neu group, bought the Chicago- based United Re­cy­cling In­dus­tries and ac­quired the end- of- life re­cy­cling as­sets of No­randa Re­cy­cling, as well as a num­ber of smaller ac­qui­si­tions.

The strat­egy has been a timely one, given the rav­en­ous need of the Chi­nese econ­omy for iron ore: al­though China is not a big user of scrap ( it has gone down the blast- fur­nace path for steel­mak­ing, which uses iron ore and cok­ing coal, rather than the elec­tric arc fur­nace mini- mill’, which uses scrap), Chi­nese de­mand for iron ore has had flow- on ef­fects in the scrap mar­kets as world steel­mak­ers fight to se­cure sup­ply of raw ma­te­rial.

Scrap is also in­creas­ingly pop­u­lar on en­vi­ron­men­tal grounds: scrap does not have to be mined, and steel made from scrap uses only one- third as much en­ergy as that pro­duced from iron ore. Be­cause of th­ese fac­tors, the steel scrap price has been pushed to record lev­els, well be­yond the point where us­ing scrap metal makes sense for many mills.

In Jan­uary 2006 the bell­wether No. 1 heavy melt scrap ( HMS) grade fetched $ US215 a tonne. By Jan­uary 2008 it traded at $ US390 a tonne; last month, the price had hit a record high of $ US650 a tonne. Auto fac­tory scrap costs even more: it has risen about 70 per cent since March, to as high as $ US710 a tonne.

Sims is ben­e­fit­ing hugely from th­ese prices. Four years ago, in the 2003- 04 fi­nan­cial year, it earned net profit of $ 119 mil­lion: its profit for the three months end­ing March 31 2008 came in at a record $ 80.3 mil­lion ( up 46 per cent on a year ago) and it is ex­pected to earn about $ 320 mil­lion for the full year, com­pared to $ 254 mil­lion in 2006- 07.

Not sur­pris­ingly, the share price has fol­lowed a sim­i­lar tra­jec­tory to the profit growth: from $ 11 in mid- 2004, it has risen to $ 35.

Sims it­self is con­fi­dent of the good times con­tin­u­ing in the short term at least. Chief ex­ec­u­tive Daniel Dienst is fore­cast­ing a strong out­look for the fi­nal quar­ter of the fi­nan­cial year, say­ing earn­ings will ex­ceed that of the third quar­ter, as the com­pany gets the ben­e­fit of its first full- quar­ter of earn­ings con­tri­bu­tion from Metal Man­age­ment.

While the strength of the Aus­tralian dol­lar and higher freight rates to trans­port its prod­uct re­main head­winds for the com­pany, Dienst says strong prices for fer­rous scrap glob­ally are more than off­set­ting the stronger Aus­tralian dol­lar, de­mand and pric­ing from con­sumers for Sims’ fer­rous and non- fer­rous met­als is ro­bust, and freight rates have sta­bilised — al­beit still at his­tor­i­cally high lev­els. This all sup­ports the com­pany’s ex­pec­ta­tion for con­tin­ued at­trac­tive op­er­at­ing con­di­tions’’ through to the end of the fi­nan­cial year. For a com­pany as con­ser­va­tive as Sims in the guid­ance it gives the mar­ket, that is tan­ta­mount to whoop­ing it up.

Dar­ren Grubb, an­a­lyst at In­ter­su­isse, says mar­ket con­di­tions mean that the fourth quar­ter will be an­other record’’ for Sims, but adds that the com­pany is un­able to pro­vide more pre­cise es­ti­mates given the un­prece­dented volatil­ity’’ in scrap prices and freight prices in re­cent quar­ters.

Grubb notes that sales ton­nages for the nine months of the fi­nan­cial year so far are up only 3 per cent, mean­ing that most rev­enue growth has come from high scrap prices — and while he likes the long- term out­look for both fer­rous and non- fer­rous prices, with ris­ing iron ore and cok­ing coal prices en­cour­ag­ing sub­sti­tu­tion into scrap metal, he cau­tions that scrap prices are volatile, and will not rise for­ever in a straight line’’. While Sims has been a good trade’’, Grubb says that some cau­tion is re­quired’’ af­ter a 49 per cent rally in the stock price this year. He rates the stock as an ac­cu­mu­late’’.

Sim­ply put, Sims is pay­ing the price for its suc­cess, in a fully val­ued share price. At $ 35, Sims is trad­ing at about 18 times ex­pected earn­ings, com­pared to its long- term his­tor­i­cal av­er­age of 11 times. Bro­ker Citi says that this dis­crep­ancy is two stan­dard de­vi­a­tions above its his­tor­i­cal price/ earn­ings ( P/ E) ra­tio — mak­ing the stock over- val­ued.

While con­di­tions for Sims con­tinue to be pos­i­tive, says Citi, this is more than fac­tored in’’ to the cur­rent share prices, mak­ing the stock ex­pen­sive — par­tic­u­larly as it is trad­ing on peak cy­cle earn­ings’’. Citi also sees fur­ther mar­gin pres­sure build­ing, given that Sims’ mar­ket is an in­creas­ingly com­pet­i­tive arena: the bro­ker notes that its mar­gins have been slashed in half since 2004.

Brass from muck: Sims re­cy­cles metal, and a host of other ma­te­ri­als. The com­pany has ex­panded in­ter­na­tion­ally and now has its head­quar­ters in Amer­ica

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