Last week, Sims Metal Management Ltd's (ASX: SGM) share price hit a 52-week low of $9.04. As an investor this can be a great opportunity to purchase stocks. Let's take a closer look at Sims.
With roughly 270 facilities spread across five continents, Sims is the world's largest publicly traded scrap metal recycling company. Although two thirds of Sims' revenue stems from the sale of ferrous scrap metal, the company also sells nonferrous scrap metal, including aluminium, lead, copper, zinc, and nickel, and recycles post-consumer electronics such as televisions, radios, and computers. Sims reports via three distinct geographic divisions: North America, Australasia, and Europe.
The majority of Sims' shipment volume is associated with the sale of scrap collected in the U.S. Through Sims' North American recycling operations, the company generates 20% of its revenue from sales within the United States.
Key export markets include Turkey and China, which have accounted for roughly 18% and 15% of the company's total sales, respectively, in recent years. Overall, the key drivers of Sims' earnings potential are scrap availability in the United States, scrap demand in Turkey, and scrap demand in China.
While there are a number of things that will impact the future of Sims, one big question we need to ask is, "Will Turkey and China continue to be large importers of ferrous scrap metal"?
To answer this question we need to understand how steel is made. Basically, to make steel you can use virgin iron ore, or you can use recycled ferrous scrap metal. Ferrous metals are those which contain iron, whilst non-ferrous metals don't have any iron content.
As ferrous scrap metal is a more environmentally friendly steel-making raw material than iron ore, this should drive scrap demand growth as steelmakers grapple with carbon emission standards and environmental awareness becomes increasingly important. Therefore Chinese mills are more likely to increase their ferrous scrap consumption in years to come.
If this is the case, then this would positively impact Sims.
Another important question that will impact the future of Sims is, "What is the trend of scrapping rates generally"?
The company collects scrap in the U.S., U.K., and Australia, and although these three countries exhibit high scrapping rates relative to emerging markets, their scrapping rates have declined in recent years. This is due to the fact that consumers in the developed world have held onto their cars and appliances for longer periods of time since the onset of the global financial crisis as economic growth remains sluggish.
Improving consumer confidence in the United States and Europe should lead to higher scrapping rates and scrap demand in emerging markets will grow along with the need for more comprehensive infrastructure.
If this is the case, then this would positively impact Sims.
Competitive Advantage
In addition to the above, Sims' shipping operations are able to generate meaningful economies of scale thanks to the 10 deep-water port terminals from which the company operates.
Sims owns half of these terminals and has exclusive leases for the rest. However, deep-water ports are highly capital-intensive assets that can dilute company-wide returns on invested capital when not fuelled by healthy throughput levels.
Port ownership provides Sims with a barrier to entry that prevents competitors from exporting scrap from the same region, which means Sims is generally able to maintain higher profitability in those areas.
Revenues and net profits
Based on Sims' annual reports we can see that revenues have been reasonably flat, and net profits have been negative in three of the past five years. Losses however, have been reducing significantly.
| Amounts are in millions | 2010 | 2011 | 2012 | 2013 | 2014 |
| Revenue | 7,458 | 8,852 | 9,042 | 7,203 | 7,144 |
| Net Profit | 126 | 192 | (622) | (466) | (88) |
Source: Company Annual Reports
Low debt and strong cash flows
While net profit has been negative, the company has had positive 'cash flows after investing'. In 2014, Sims posted a loss of $88 million, while still having $209 million in 'cash flows after investing'. The company used this surplus to pay down $200 million in debt. This left Sims with just $15 million of debt on its balance sheet and cash and cash equivalents of $57 million.
Outlook 2H FY15
The company stated in its third quarter FY15 update that:
"The steep drop in iron ore prices and adverse weather conditions in North America have resulted in a significant reduction of ferrous scrap prices and volumes during the third quarter of the current fiscal year. As weather conditions improve in the fourth quarter of FY15 and ferrous scrap prices stabilise, material flow and sales volumes are anticipated to increase. However, this is unlikely to fully offset the impact of the severe conditions faced during the third quarter".
"Despite markedly lower sales volumes, the Company currently expects 2H FY15 underlying EBIT to be in line with the prior year period 2H FY14 underlying EBIT."
Verdict
I think Sims has done a great job of cleaning up its balance sheet and has 'strong cash flows after investing'. I also think that China and Turkey will continue to be large importers of ferrous scrap metal, and scrapping rates and scrap demand in emerging markets will grow.
Sims is also able to generate meaningful economies of scale thanks to the 10 deep-water port terminals from which the company operates.
But, the reality is that, by its own admission, larger factors such as the drop in iron ore prices and weather conditions are continuing to negatively impact this business. This drop in iron ore prices makes it cheaper for some steel mills to use iron ore.
That's why, at least for now, I could not consider Sims a 'buy' even at its current price of $9.20.
