Sims says declining zorba market, difficult trading conditions affect margins

Sims Metal Management Ltd., with its head office in Rye, New York, says it expects underlying earnings before interest and taxes (EBIT) of $110 million for the first half of its fiscal 2019 based on preliminary results that are still subject to management sign off, board sign off and audit review.

“The first half has been challenging for all recycling companies globally and will continue to be so for the near future,” states Alistair Field, CEO and managing director of Sims, in a press releases announcing the anticipated results. “We are meeting these challenges and will maintain our focus on capitalizing on our strengths and on improving underperforming businesses. I am confident that our strategy of producing high quality products that better meet the needs of our customers is key to our long-term success.”

The company says it will release its results for the first half of 2019 Feb. 20.

According to the company’s initial reporting, despite the lower exchange rate between the Australian and U.S. dollars, Sims’ North America Metals business experienced some EBIT contraction in the first half of its 2019 fiscal year compared with the comparable period in fiscal 2018. This contraction was driven in part by an increase in internal recharges from group corporate overhead. For North America Metals, these internal recharges were $8.3 million higher in the first half of fiscal 2019 than in the first half of fiscal 2018, the company says.

Market volatility has steadily increased throughout the half because of the uncertainty surrounding tariffs, trade wars and Turkey’s position in the market. Sims says that over the medium term its operating businesses should be relatively neutral to this volatility but that margins could be affected over shorter time frames. This occurred in October and, to some extent, November in the first half of fiscal 2019 where, following some sales, the market spiked higher, which increased the purchase price for scrap to fulfill those sales, resulting in a lower margin than expected, Sims explains. While some of this was recouped in December as the market fell, it was not as much as management had anticipated.

The level of competitor activity at selected sites for purchasing scrap increased. While this is not unusual, it was particularly strong at those sites over the second quarter of the first half of the year, the company adds.

Sims’ Europe Metals business experienced difficult trading conditions during in the first half of 2019, according to the company, resulting in a nearly 88 percent reduction in underlying EBIT compared with the first half of fiscal 2018. An increase in internal recharges to Europe Metals accounted for $2.5 million of the underlying EBIT reduction, Sims says. However, the more significant balance of the reduction was driven by three main factors.

Historically, including in the first half of fiscal 2018, its Europe Metals’ access to the deep-sea Turkish market provided a premium price over other sales outlets, such as short sea, container and domestic, the company says. But challenges in the Turkish economy have eradicated this premium in the first half of 2019. Competitive pressure means the purchase price for scrap has not reduced to compensate for the lower premium, resulting in margin compression.

Additionally, Europe Metals’ Turkish customers have increased their requirement for higher quality ferrous scrap. Management has responded by implementing stricter controls on quality into sites, Sims says. However, as a consequence, some volume has been lost, with some competitors still willing to accept lower quality intake.

Margins related to nonferrous products have also reduced for two main reasons, the company says. First, the reduction in the sales price for zorba and related products has not yet seen a commensurate reduction in the buy price for shredder feed in the U.K. market, thereby compressing margins. Second, EBIT contribution in the first half of 2019 from sales of items such as insulated copper wire and electric motors has fallen because of the National Sword initiative in China. While Europe Metals has responded to this issue by installing copper granulation plants, EBIT contribution from these investments is not expected until the second half of the fiscal year.

Sims says its SA Recycling business also experienced difficult trading conditions during in the first half of fiscal 2019, resulting in a 33 percent reduction in underlying EBIT compared with the first half of 2018. The lower underlying EBIT primarily related to the fall in zorba prices, Sims says, noting that SA Recycling has 13 shredders and operates against competitors that perform rudimentary shredding that does not yield significant nonferrous product in many locations. Therefore, when zorba prices fell from as much as 65 cents per pound in second half of 2018 to as low as 40 cents per pound in the first half of 2019, some competitors did not reduce the buy price for shredder feed. To protect volumes, SA Recycling had to pay this elevated price, which reduced margins, Sims explains.

In addition to margin compression on zorba, the first half of fiscal 2019 witnessed a general compression in ferrous margins, the company says. SA Recycling’s volumes increased 14 percent in the first half of fiscal 2019 compared with the first half of fiscal 2018. However, volumes in first half of 2018 decreased 10 percent compared with the second half of 2018. Efforts to protect volumes in the first half of fiscal 2019 resulted in higher purchase prices and corresponding margin compression, Sims notes.

The company’s Corporate & Unallocated business shows an underlying EBIT improvement of $1.9 million. Sims Municipal Recycling, the company’s municipal recycling business, is within this segment, and its underlying EBIT fell from approximately $3 million in the first half of 2018 to a loss of roughly $4 million for the first half of fiscal 2019. The company says this is because of the collapse in waste paper pricing to below zero.