Incitec Pivot At Start Of Upgrade Cycle?

This story features INCITEC PIVOT LIMITED. For more info SHARE ANALYSIS: IPL

By Chris Shaw

Fertiliser and agricultural chemicals group Incitec Pivot ((IPL)) delivered a positive earnings surprise yesterday, its full year profit result of $442 million coming in about 13% higher than consensus forecasts.

Citi saw the better than expected result as being driven by Project Velocity related cost reductions of $77 million and lower interest charges during the period. From a divisional perspective, UBS notes the fertiliser business outperformed, this thanks to a leveraging of improvement in soft commodity markets.

Project velocity is an attempt to improve operating efficiencies and lower group costs, RBS Morgans noting the target is US$204 million of benefits by FY12. The FY10 result shows some of these benefits have come sooner than expected, but fully realising the goals will require an improvement in volumes and so remains a challenge in the broker's view.

In terms of the outlook for 2011, Credit Suisse suggests positive earnings momentum should continue as Incitec Pivot at present is enjoying a combination of strong fertiliser prices, a solid soft commodity market, good hedging of currency exposure and a lower interest expense.

According to Credit Suisse, fertiliser driven market earnings upgrades for Incitec Pivot appear inevitable post the full year profit result and increases of around 10% are likely in the broker's view. RBS Australia agrees, taking the view the combination of improved seasonal conditions and rising fertiliser and soft commodity prices is likely to create a cycle of earnings upgrades for the coming year.

In the fertiliser market specifically, RBS Morgans notes the market remains tight thanks to strong demand and limited supply. Even allowing for recent increases to its fertiliser price forecasts, the broker continues to view risk to the upside. This is thanks to reports China may bring forward its export tax, which would reduce Chinese exports and so further tighten the global market.

Given it was already above the market with its FY11 numbers, Credit Suisse has only lifted its forecast by 3.1% to a reported net profit after tax of $558 million. In earnings per share terms this means Credit Suisse is now forecasting 30.8c in FY11 and 35c in FY12, which compares to respective consensus forecasts according to the FNArena database of 29.2c and 30.5c for FY11 and FY12.

These consensus numbers have indeed been lifted post Incitec Pivot's full year result, as UBS for example increased its forecasts by 7% in FY11 and by 4% in FY12, while Deutsche Bank has lifted its numbers by 4-6% through FY12.

Earnings could still be somewhat volatile for Incitec Pivot, as RBS Morgans points out a US$10 perr tonne change in DAP fertiliser prices has an A$11.5 million impact on earnings before interest and tax (EBIT), while a US$10pere tonne change in urea prices has a A$4.8m impact on EBIT.

Currency moves are also an issue, as the broker estimates the transactional earnings impact is A$7.2 million for every 1c change in the AUD/USD exchange rate, while the translation impact is A$1.8 million for every 1c move.

With the increases in earnings forecasts has come an increase in price targets, the FNArena database showing the consensus price target for Incitec Pivot is now $4.04. This is up from $3.89 prior to the full year result.

There is a wide range of broker price targets, Credit Suisse leading the way with a target of $4.52, up from $4.10 previously. At the other extreme is Deutsche Bank with a target of $2.65, up from $2.50 previously.

Given its low target it is little surprise Deutsche Bank rates Incitec Pivot as a Sell, the broker estimating at current levels the stock is trading at a 42% premium to valuation and a 35% premium to its North American peers.

This is the only Sell rating on the stock, the FNArena database showing five Buy ratings for Incitec Pivot and two Hold recommendations. Credit Suisse and RBS both see increases to market earnings forecasts providing some support for the stock and so justifying their respective Buy ratings, while UBS suggests the stock is fair value, making its Neutral rating appropriate.

Shares in Incitec Pivot today are slightly stronger and as at 11.30am the stock was up 4c at $3.81. Over the past year the shares have traded in a range of $2.54 to $4.00 and at current levels there is implied upside of about 5% to the consensus price target in the FNArena database. Note: the consensus price in itself is negatively impacted by the low target set by Deutsche.

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