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Morningstar | Value Creation Under Sims’ Scrap Metals Strategy Questionable; Reiterate FVE on Analyst Transfer. See Updated Analyst Note from 16 Apr 2019

No-moat-rated Sims’ recently revised strategy includes some promising elements. However, we question whether its scrap metals strategy, which will see North American ferrous volumes increase by 40% and non-ferrous volumes double over the coming six years, can deliver value for shareholders. But with much of the new strategy guiding long-term direction, our earnings estimates are unchanged. Therefore, we retain our fair value estimate of AUD 10.10 per share and our no-moat and high uncertainty ratings following a transfer of analyst. Following share price weakness, Sims’ shares screen as fairly valued.

The revised strategy positions the company for growth in an increasingly circular economy, in which the waste of resources is being progressively minimised. Sims’ scope will be broadened both within its existing e-recycling franchise and further afield in renewable energy. Sims aims to become a leader in cloud hardware recycling and will also become a renewable energy player, leveraging the expertise of its joint venture partner, LMS energy, in landfill energy generation. Further, Sims’ waste-to-energy program will capture its currently landfilled, non-metallic shredding waste within its metals business and utilise it in electricity generation via gasification technology.

We continue to anticipate low-single-digit metals shipment volume growth across all regions in our forecast and a weakening in operating margins due to our midcycle iron ore price assumptions. The ferrous scrap metal benchmark is tied closely to iron ore, and Morningstar’s forecast calls for the benchmark 62% fines iron ore (CFR Tianjin) to decline from an average of USD 69 per tonne in calendar year 2018 to USD 40 per tonne by 2023. This drives our operating margin projection to 2.6% by fiscal 2021 from 4.0% in fiscal 2018. We continue to see an average 6.9% return on invested capital through a full cycle over the next five years, short of the firm’s cost of capital estimated at 8.9%.