Join the scramble for scrap

As demand for scrap metal increases, the price is forecast to rise sharply. We look at why there has never been a better time to be in the business of recycling metal and pick one company set to benefit…

America is being stripped bare by a band of modern-day barbarians. But these marauders are a little more choosy than their historical counterparts. Rather than sacking towns indiscriminately, they are only interested in one thing metal.

In California, farms have been devastated as copper-wired irrigation systems are ripped out of the ground. In St Louis, churches have been stripped of their roofs. And in Cleveland, commuters enter the city at night in the pitch dark after thieves pilfered the street lights.

But there's no mystery as to where all the bounty is ending up. With the price of metals soaring on global markets, scrap metal yards across the States have been inundated with methamphetamine addicts, who have discovered they can feed their habit by hawking everything from beer kegs to road signs to manhole covers.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

And while Washington is finally cracking down on metal theft, there is no shortage of industrial steel companies and construction companies from the Far East calling on the scrap yards. The price of scrap metal is forecast to rise from $382 a tonne this year to $418 next year, double the price it was five years ago. There has never been a better time to be in the business of recycling metal.

Worldwide, the recycling of metal is a $65bn industry, with players including everyone from billion-dollar corporations down to rag-and-bone men. The US is by far the biggest player in the market. With China crying out for raw materials to construct its skyscrapers and airports, US metal recyclers exported $15.7bn worth of scrap metal last year.

Up until recently, the US metal recycling industry was dominated by small family-owned yards. Because of the weight of the product, and the cost of shipping, the business was necessarily regional. After shredding and melting down car wrecks and shopping trolleys, the recycled scrap was sold onto furnace mills and metal brokers. With little need to attract investment or hire labour, it remained an unassuming business.

But the yards were shaken up once the demands from Asia started coming in. National metal recyclers, who had the resources to afford long distance transportation, started snapping up smaller yards, culminating in the recent merger between industry giants Metal Management and Australia's Sims Group. Now trading scrap metal is more akin to trading stocks on the market. Sitting in their offices, metal recyclers keep one eye on the conveyer belt in the yard and one eye on world metal prices on computer screens.

This is where the big worry lies for scrap merchants of course. There has been such a phenomenal run-up in metal prices in recent years the price of copper has jumped 322% since 2003, while steel has raced to $256 per ton from around $120 since then that metal recyclers are expecting a fall back any time now, particularly as the US slowdown threatens to hammer global growth.

But as much as a slide in metal prices would hurt business, the metal yards are not about to grind to a halt anytime soon. The other big benefit of recycling metal is in the greenhouse gas savings made compared with the energy consumed when mining fresh metals out of the ground. For example, recycling aluminium takes 95% less energy than extracting new aluminium. With countries and companies around the world keen to cut their carbon footprints, demand for scrap is underpinned by more than just high metal prices. We look at one company set to benefit below.

The best stock in the metal recycling sector

With the recent $1.7bn acquisition of Metal Management, Australia's Sims Group (NYSE:SMS) is by far the largest recycler of metal in the world. However, on a forward p/e of 15.6, the stock looks a little too expensive just now.

A smaller but much faster-growing metal recycler is Amex-listed Metalico (MEA). A buyer of metal scrap, Metalico then processes it into reusable forms, and then sells the recycled metals to mills and furnaces in the US and the Far East. International demand for steel, copper and aluminium has seen Metalico record 46% annual growth in sales since 2003.

The bulk of the $330m company's operations are in upstate New York but it has operations spread across the country. It is a small player by the standards of the industry, but one that is growing rapidly.

Next Generation Equity Research analysts expect earnings per share to come in at $0.77 this year, up 45% on 2007. In terms of risks, a strengthening in the dollar (which would hit exports) or a drop in the price of iron ore, ferrous scrap and lead (which seems the more likely threat, if recession starts to bite), could hurt revenues. But with Metalico trading on a forward p/e of 11.3 for 2009, and with a price to earnings growth ratio of just 0.3, the stock looks good value.

Eoin came to Money Week in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.

Eoin acts as managing editor of MoneyWeek's newsletters.