Why Sims Metal Management (ASX: SGM) is a stock to buy

 This article was originally published at MF & Co. Asset Management.

Sims Metal Management Limited (ASX SGM) is the leading metals and electronics recycling company in the world. The company has streamlined its operations and built a reliable supply chain by integrating complementary firms. SGM has a strong distribution network that can reach the majority of the potential market.

However, the political changes in product standards and the fluctuation of the currency exchange rate would significantly affect its sales in target markets since SGM has operations in numerous countries.

About Sims Metal Management (ASX SGM)

Sims Metal Management’s activities focus on ferrous and non-ferrous secondary recycling, including post-consumer recycling and curbside waste recycling. The curbside waste recycling involves the purchasing, collection, processing and resale of iron and steel and other metal alloys material, and disposal of electronic and electrical equipment and IT asset management and recovery solutions for commercial customers.

Sims has around $3.2 billion market capitalisation, which is third largest after competitors Northern Star Resources Limited and Mineral Resources Limited within the metals and mining industries Australian exchange market.

A Reliable Supply Chain Built Up Due to Global Acquisition

SGM has merged large metal recycling companies in the UK, US, Australia, New Zealand and Asia, which helped has the company to streamline its operations and build up a reliable supply chain over five continents.

The company’s acquisition strategy enables the expansion of the market. With the regulation of a coordinated plan to close inefficient steel mill capacity, China became the largest customer for SGM in 2017.

Apart from incremental demand for non-ferrous secondary metals globally, a new fully dedicated deep-water export and scrap metal handling facility at the Port of Sheerness crowns Turkey as one of the biggest markets of consumers followed closely by the U.S. and China.

SGM mainly sells iron and steel secondary raw materials, metal alloys and residues such as aluminium and zinc, these restricted product options could hinder subsequent expansion for the company and give competitors an opportunity to enter the market.

Culture integration resulting from merger and acquisition could also affect the company’s working efficiency and profitability. SGM’s new management has created the Cross Functional Expertise Board (CFEB) to seek culture change and implementation across all businesses; however, they still need time to adjust it.

Political Change Is a Double-edged Sword

Political regulation is a big issue for bulk commodities such as metal and steel products, especially in the biggest target markets. The coordinated plan to close inefficient steel mills in China resulted in a 21% reduction in steel exports in FY17, which pushed up raw material prices in the global market. The new steel import policy in the U.S. makes steel largely exported to Europe, and now the EU is considering putting a tariff on steel.

Furthermore, exchange rate fluctuation has become a material problem for SGM. Sales revenue of SGM was $5,079 million in 2017, but the cumulative effect of the retranslation of net assets of foreign-controlled entities was A$116.8 million.

The political changes provided an opportunity for SGM as well. Donald Trump’s metals tariff plan promotes selling steel through local companies, making operations of Sims in the U.S. more competitive and would result in an increase in sales revenue in the following years.

In addition, Sims pays close attention to new technology development, enabling SGM to practice a differentiated pricing strategy in new markets and maintaining its loyal customers by providing high-quality products and services.

SGM Is Making A Higher-Than-Average Profit in Metal & Mining Industry

ASX SGM has converted a loss of 2016 into EPS of 1.082% since 2017 which is higher than the EPS of 0.536 in 2015 as well as trailing twelve months’ industrial level of 0.32%.

The profit margin of 4.0% is much higher than the industrial level of negative 4.51% in 2017, which means that most companies in the metal & mining industry are at a loss in 2017, but Sims Metal Management has good management and operations and should use its resources efficiently and eventually make profits.

ASX SGM ROE of 10.35% is also much higher than a benchmark of 0.05%, which means the company’s shareholders have a higher return on their investment than other competitors in the industry.

ROE ratio also indicates from 2016, the whole industry has gone into difficulties due to economic conditions, and even Sims Metal Management suffered a loss, and in 2018, the overall industry started recovering and gradually making profits. Consequently, Sims Metal Management started making a profit earlier than others in 2017.

Its P/E ratio is 14.57 which is similar to the industrial level of 15.14, which reflects the company is in a mature stage of growth but may be slightly undervalued compared with the benchmark.

The P/B ratio is 1.75 higher than the 1.2 industry level, which indicates that investors are willing to pay a higher premium for the company because of its higher quality.

Bright Future Ahead Despite Political and Cultural Issues

 Even though political changes and cultural integration problems are an issue, this should not hinder growth because a global reliable supply chain helps Sims Metal Management to further explore markets. New technology development within the organisation will also enable higher quality products with lower prices.

This article on Sims Metal Management is written by Henry Fung, Managing Director at MF & Co. Asset Management, a boutique investment firm based in Sydney, Australia. For MF & Co.’s full website and further articles follow the link: MF & Co.

Categories: Australian Stocks

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