Australia | Mar 19 2013
-Earnings impact from weather, Minova
-Brokers downgrade forecasts
-But there are some positives
-Hope in future strategy
By Eva Brocklehurst
The flooding of Australia's east coast coal fields this year, in particular the duration of the wet in NSW, has caused Orica ((ORI)) to reduce forecast explosives volumes and mark down earnings expectations by $10-15 million. The company advised of the earnings impact in an investor conference yesterday and also flagged ongoing weakness in the Minova business, which supplies consumables and services to the mining industry. These were the two main negative implications from the briefing, but brokers took heart from the fact that the company did not downgrade full-year profit guidance.
The market's negative share price reaction to Orica's news was overdone as far as JP Morgan is concerned. The broker has still downgraded forecasts for FY13 earnings but believes the majority of this will come from the low valuation Minova business. To put this in context, a 23% reduction in the broker's forecasts for Minova reduces group earnings forecasts by 2%. The downgrade for explosives earnings is weather related and, therefore, should revert to mean in FY14. JP Morgan notes a lot of the volume reduction was in the Hunter Valley, in anticipation of the impact as the big wet moved south. In all, the broker considers the valuation impact on the stock is minimal. The broker suspects some analysts might be using the first half 2012 earnings and deducting $10-15m without adding back lost production margins from the Kooragang Island plant shutdown in FY12. That could understate the outlook for FY13 earnings as a result.
Minova is suffering from weak demand in both Australia and the US as well as price competition. For Macquarie, the business may be just 4% of earnings but has taken away much of the prior growth expectations. Macquarie now expects a 56% decline in Minova's full year earnings as opposed to Orica's expectations of 20%. Macquarie sees a positive in the big wet. These situations increase demand for high margin emulsion product and there is potential for the earnings to be made up later in the the year. On balance, the broker notes the key will be non-recurrence of Kooragang Island outages that took $90m out of the earnings equation previously. It just depends, when lost earnings are added back in, how much is negated by the Minova deterioration.
Deutsche Bank is quite upbeat about the future, believing the $10-15m figure is conservative and the impact could be lower, around $6.5m on estimation. The broker also highlights the company's restructuring progress with Minova. This will be completed in FY13 instead of FY14 as initially planned. Okay, conditions continue to be difficult in underground coal mining but the broker believes the company is well placed to benefit from a recovery in mining activity and suspects the market is not taking into consideration the company's strategy on operational improvement.
UBS is positive about the outlook for domestic explosives volume growth but cautious about the maintenance of margins after five years of strong growth. The supply/demand balance is becoming less favourable and when this is combined with increasing customer pressure it suggests to the broker that domestic margins have peaked. This limits the scope for earnings upside. UBS has also disagreed with Orica's target of an 18% contribution from the Bontang ramp-up, and new Burrup and Kooragang Island projects from FY16 and FY18 respectively. This is because the capital costs are high. The broker suspects the industry will not be able to support the higher ammonium nitrate prices that are required for these projects to achieve targeted returns in the years following commissioning. UBS has downgraded its recommendation to Hold from Buy.
For BA-Merrill Lynch it is clear Minova is challenged, but there is some light at the end of the tunnel. Orica indicated mining services is growing market share and increasing penetration in mine site services. Furthermore, Orica has maintained over 80% of its own contracts up for tender and won over 57% of new contracts, globally, that were previously held by competitors. The stock is the broker's pick in the sector as it retains significant leverage to continued growth in explosives volumes in Australia and Asia. There is also margin expansion from converting commodity ammonium nitrate volumes to higher value mine site services.
Morgan Stanley takes a different tack: the news is ushering in the beginning of a downgrade cycle. Morgan Stanley, which does not feature on the FNArena database, rates the stock as a Sell. A number of negative structural factors are coming into play and the broker believes the stock is expensive, given the risks. For Morgan Stanley, the company may not have altered its guidance but implies it could be forthcoming. The broker was below consensus for FY13-15 earnings forecasts and is now 7-13% below. Why is Morgan Stanley so bearish? The client base is seeking cost savings while there is a rising cost base. Import parity prices are falling and placing pressure on the company's supply and services margins. In particular, Morgan Stanley cites the risk in Indonesia from exposure to Chinese imports, noting 15% of Orica's Bontang volumes are directly exposed and contracted volumes are likely moving into a softer pricing environment.
There's no Sell rating on the FNArena database. Just six Buys and two Holds. The consensus target price, from a range of $26.60 to $31.50, is $27.93, showing 14.5% upside to the last share price. The stock shows a 4% dividend yield on consensus FY13 earnings forecasts.
