Incitec Pivot Result Exposes Uncertainties

This story features INCITEC PIVOT LIMITED, and other companies. For more info SHARE ANALYSIS: IPL

-Are price, FX headwinds abating?
-Improvement expected but when?
-Heavy reliance on Moranbah
 

By Eva Brocklehurst

Explosives and fertiliser business Incitec Pivot ((IPL)) delivered FY13 results that did not diverge too much from expectations but offered plenty of issues to prompt brokers to mull implications for the business in the years ahead.

Similar to competitor Orica ((ORI)), JP Morgan observed the response in the share price to the result was largely as a relief reaction to significant prior underperformance. This broker still does not find Incitec Pivot's valuation that compelling, with high expectations for growth outside of Moranbah factored in. CIMB acknowledges the potential for substantially stronger earnings down the track in the North American explosives market but weak urea prices and the exchange rate make it difficult to add up to growth in the short term. This broker is content to revisit the stock when there is more certainty on these items and a more compelling valuation.

One broker is most confident that headwinds are abating. Credit Suisse maintains that the planned manufacturing closure and the slow ramp up of Moranbah heralds a transition year. Exchange rate headwinds are easing and fertiliser market prices finding a base. The broker contends that macro conditions have been unkind to Incitec Pivot. Recently, the stock has traded as if it were a play on the diammonium phosphate (DAP) price, despite the company moving away from its commoditised price-taking fertiliser operations towards a better structured earnings profile via Moranbah ammonium nitrate (AN), the Pilbara emulsion and US ammonia business.

Still, the start to FY14 has made it tough. JP Morgan thinks simply achieving flat growth in the Dyno Nobel business will require some sort of turnaround, as several factors contributed to an underlying decline in earnings in the second half of FY13, including the loss of the Xstrata contract and cost increases. Macquarie highlights weak pricing for DAP and urea. Regardless of whether it's fair, Incitec Pivot is highly exposed to the DAP, urea price and FX movements. Moreover, Macquarie notes fertiliser markets are relatively well supplied for the medium term and, even though prices may be bottoming, this is likely to cap the upside. The return of demand in India is considered the potential positive for the DAP markets in April-May 2014.

DAP and urea prices may have been soft, but Credit Suisse expects a seasonally stronger period for fertiliser prices in early 2014. Significantly, DAP prices have shown their first rise this week after a long period of decline and should start to improve in early 2014, becoming more evident ahead of the North American planting season, with modest price improvements being augmented by reductions in input costs. For urea, the broker maintains that prices are in the process of bottoming out, although ammonia pricing may experience incremental pressure.

While there are a number of positives in the outlook, Credit Suisse notes the company was very cautious with its commentary and did not provide macro assumptions, or guidance regarding the timing of improvements and volume activity. Nevertheless, Credit Suisse expects that moderating headwinds and the improvements already made by the company should start to show up in the second half of FY14, and investors are expected to increasingly focus on this momentum going into FY15.

CIMB took the other tack. The results did little to convince the broker that the worst was now behind. DAP manufacturing is facing low prices and a relatively high Australian dollar as well as a ste- change in gas costs and an increase in sulphur input costs. For CIMB it means that, without an increase in DAP prices or a material decline in the Australian dollar against the US currency, the profitability of the business may remain marginal. In terms of fertiliser, Phosphate Hill is expected to run at reduced rates ahead of the planned shutdowns. Citi doesn't expect the turnaround cost at Phosphate Hill will exceed the cumulative costs of outages experienced in FY13 but agrees the business is facing sulphur price increases and an assumed increase in gas prices. The company has lost sulphur supply from Mt Isa which was at zero cost and, while the options are still being considered, a new supply is likely to have a negative impact to earnings after FY17.

So what's it to be? It's Moranbah that will have to do the heavy lifting, in Citi's view. Having left FY13 with an annualised production rate of 328.000 tonnes this increases the broker's confidence in the ability of the AN plant to deliver 300,000 tonnes and $54m in incremental earnings in FY14. The remainder of the Asia Pacific explosives business is expected to be flat. Management has signalled the US explosives business is uncertain but Citi expects the second half of FY14 will show an improvement as higher margin volumes grow.

Cash conversion was well ahead of forecasts and hailed by brokers as the most positive aspect of the results. UBS noted it reflected growth of 5% over previous year, despite lower underlying earnings. Cash conversion was driven by tighter working capital management and lower tax. Citi maintains this will be a key feature for the outlook going forward.

On the FNArena database there are two Buy ratings and six Hold. The consensus target price of $2.98 suggest 5.4% upside to the last share price and compares with $2.93 ahead of the result. The range of target prices is from $2.75 (CIMB) to $3.20 (Deutsche Bank). On consensus estimates the FY14 and FY15 dividend yield is 3.6% and 4.5%. respectively.

See also, Reliability Issues Weigh On Incitec Pivot on July 24 2013.
 

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