Australia | May 07 2013
-First half better than expected
-Brokers see long-term value
-Barriers to entry an advantage
-Cash flow improves
By Eva Brocklehurst
Diversified chemicals company Orica ((ORI)) pleased the market with a solid half year result, better than many had feared. Also, management indicated a trough was likely for the Minova business, which has been the cause of much angst among brokers.
Citi remains the most cautious, and the one with a Hold rating on the FNArena database. The broker found the $90 million benefit from the normal operation of Kooragang Island a key growth driver. Sodium cyanide and emulsion sales helped to some extent. Minova was weaker than the broker expected, and Bontang plant costs also impacted. Orica is confident that margin improvement will drive growth but Citi is not so sure, expecting ammonium nitrate pricing pressures could be the next hurdle. The broker remains wary of the deteriorating mine production outlook and cost conscious miners and sees limited upside in volumes and price. Citi has cut Minova earnings forecasts for the year by 20%.
Goldman Sachs believes taht while investing in mining services companies may be counter-intuitive at present, the company offers a more resilient earnings path than the market price is currently giving it credit for. The stock is one of the few in the basic industrials segment that the broker thinks represents good long-term value. CIMB also thinks the stock is a core portfolio holding and welcomed the greater clarity which came with the result. CIMB believes the company offers a strong market position, protected by real barriers to entry which provide a sustainable competitive advantage. The stock is trading at a material discount to its typical range relative to market and CIMB expects the latest result should enable a re-rating.
Credit Suisse finds the potential to achieve 12 years of profitable growth in FY13 is highly commendable, given recent adverse conditions and weak end-markets. This broker also sees the market leadership of Orica tightening as the barriers to entry are raised. Productivity and efficiency benefits may become harder to realise but Credit Suisse does not under-estimate the reinvigorated management team.
Strategically, the greatest operational risk is balancing of Asia Pacific ammonium nitrate supply and demand. Credit Suisse thinks balance should be maintained with imports being displaced, although unless underlying demand accelerates in FY14 there could be marginal oversupply. This implies that Kooragang Island expansion is unlikely in the foreseeable future. Credit Suisse thinks this should free up significant capital. The broker finds it hard to get excited about Chemnet and Chlor alkali businesses and believes, with no mining services exposure, ownership under Orica could be tested medium term. This is particularly so given the number of competitors that are owned by private equity. There's no compelling need to offload these businesses but Credit Suisse would not rule out Orica moving towards 100% mining services over coming years.
UBS made few changes to earnings forecasts. Lower operating earnings from Minova and chemicals is largely offset by lower net interest costs. What did surprise the broker was cash flow. Underlying operating cash flow improved significantly on the prior year. As a result net debt was better than expected and, with a better interest rate environment helped drive lower interest costs. UBS also sees little need for the Kooragang Island project through to 2020 and continues to exclude it from capex forecasts. The broker finds there is scope for raising the pay-out ratio, currently 55%, and other capital management initiatives in FY14.
Macquarie hailed the healthy cash flow, noting first half results had disappointed in recent years but this time the cash flow was ahead of forecasts. The explosive business remains resilient and the company is seen benefiting from a shift into emulsion products. The broker remarked on the company's push to increase on-site product and services supply against product only. New contracts show an increase in the mix of on-site product and services to 70% of sales against 39% six months ago. Supplying product only has reduced to 26% from 61%. Emulsion sales rose to 62% of revenue compared with the December half's 57%. Emulsion was used mainly in wet environments but is now more widespread. The ammonium nitrate solution is combined with emulsifier to make it more flexible in application, more energy efficient and with less fumes. It is higher margin but there is productivity benefit which justifies this higher price, in Macquarie's view.
What was particularly negative? European results. Europe's earnings were down 55% on the prior corresponding half, driving much of the weak Minova business as Europe faced a colder-than-usual winter with declines in explosives volumes/margins in Western Europe and Scandinavia. Minova was also affected by weakness in North America. Minova remains the key to upside for Macquarie, for the earnings are considered high risk. The broker accepts that, if there is indeed a troughing in the business, this would be a positive driver of the share price.
The stock has seven Buy ratings on the FNArena database and one Hold. There is no Sell rating. The consensus target price is $26.68, suggesting 18.5% upside to the last share price. The range of targets is $24.75 to $31.50. The dividend yield is 4.3% on FY13 and 4.7% on FY14 consensus forecasts.
See also, Orica Detonates Concern Over Earnings on March 19 2013.
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