The Sims Metal Management Ltd (ASX: SMN) share price has rallied with the broader market but a top broker is predicting that the stock is likely to underperform over the next 60 days.
The warning has fallen on deaf ears today as a risk-on rally bolstered almost every sector on the market – pushing the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index up 0.7%.
Tech stocks led the charge with the Eclipx Group Ltd (ASX: ECX) share price claiming the top spot on the ASX 200 leader board as it surged over 11%, while the Altium Limited (ASX: ALU) share price chalked up a 4.6% gain.
Why Sims Metals is at risk of metal fatigue
Sims Metals also climbed although its share price only managed to eke out a 0.3% gain to $9.36. The problem is Morgan Stanley doesn’t think the good times will last for the metal recycler as it believes there is a 70% to 80% chance that the stock will fall relative to the market over the next 60 days.
“This is because of earnings risk associated with falling scrap prices. Against this backdrop we believe SGM will face downwards earnings risk as a result of lower prices and lower volumes,” said the broker.
Morgan Stanley had downgraded Sims Metals to “neutral” from “overweight” on Monday.
Cheap doesn’t make a stock a buy
Only three of the eight brokers polled by Reuters have a “buy” rating on the stock even though its trading on a FY20 consensus price-earnings multiple of around 10 times.
This suggests that a lot of the earnings risks may be already priced into its shares and Morgan Stanley’s price target of $10.50 certainly suggests this could be the case.
This doesn’t mean the stock is a buy though. Looking somewhat cheap isn’t always enough to win back investors. A good value stock usually needs some catalyst to trigger a share price bounce and this could be the missing ingredient for Sims Metals.
Also, if Morgan Stanley is right about the outlook for scrap, the stock could face more downward pressure at the company’s next update if management doesn’t suggest that the worse is over.
From that perspective, it’s better to buy shares in BHP or Rio Tinto in my view as these cashed up miners have at least scope to deliver capital returns to shareholders in the near-term.
You only need to look at the surge in Fortescue Metals Group Limited (ASX: FMG) share price this week to see how a cashback can excite investors.
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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.