Ammonium Nitrate Oversupply Could Pressure Orica’s Earnings

This story features ORICA LIMITED. For more info SHARE ANALYSIS: ORI

By Chris Shaw

According to Bank of America Merrill Lynch numbers, the North American ammonium nitrate market is likely to see oversupply of 300-400,000kst this year, a situation the broker suggests could last for several years if there are not capacity closures in the industry and a solid pick-up in demand.

This has potential implications for Orica ((ORI)) as the company is the second largest ammonium nitrate supplier in the US market, meaning any oversupply scenario could force the group to not only reduce the amount of material it purchases from third parties, but to also adjust its own output levels.

As the broker points out, conditions in the coal market have a big impact on the ammonium nitrate market as lower demand from power plants means lower coal output and so less need for ammonium nitrate. As such, signs Canadian coal export supply is down by about 13% this year suggests weaker demand in the US.

Potentially this could flow through to Orica cutting output at its 550kst ammonium nitrate plant in Canada, so to reflect this BA-ML has lowered its earnings forecasts in coming years. For FY09 the broker has lowered its numbers by 4%, increasing to 7% in both FY10 and FY11, meaning in earnings per share (EPS) terms it now expects 164c, 169c and 180c respectively for FY09-FY11.

This compares to consensus forecasts for FY09 and FY10 in the FNArena database of 167.3c and 173.8c respectively, implying some chance of downward revisions to consensus numbers if the Bank of America Merrill Lynch view proves to be correct.

While the broker is cautious on the shorter-term outlook for the stock, it remains positive on the company’s longer-term future given Orica operates in the high growth mining services sector, meaning it is these temporary issues that are holding BA-ML back from switching to a more positive rating.

Value is also an issue as despite a lift in price target to $21.00 from $18.50 the broker points out the share price remains at a modest premium to its new target, this despite the potential for the shorter-term ammonium nitrate oversupply issues to weigh on the share price in coming months.

Bank of America Merrill Lynch’s target compares to an average target according to the FNArena database of $20.50, so others in the market tend to agree the stock is fair value at present. Ratings reinforce this view as the database shows three Buy ratings, one Accumulate, Five Holds and one Sell recommendation. This comes courtesy of RBA Australia, the broker arguing the cyclical nature of the group’s businesses means earnings pressure should remain for some time yet.

Shares in Orica today are slightly higher in early trading and as at 10.40am the stock was up 9c at $21.32. This compares to a trading range over the past year of $10.75 to $27.54.

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