Chinese Fertiliser Tax Smelling Good

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

By Andrew Nelson

The Chinese Government has increased and extended export tariffs for key fertiliser ingredient Urea and introduced special export tax on ammonium nitrate until the end of the calendar year. However, the overall upside for fertiliser makers in Australia, Incitec Pivot ((IPL)) and Orica ((ORI)) is somewhat offset by a downwardly revised export tax rate on phosphate fertilisers.

JPMorgan notes that China, looking to guarantee supply and control prices for Chinese farmers, had initially imposed special export tariffs of 100% on fertiliser and fertiliser raw materials from April 20 to September 30, 2008. This rate was applied over and above existing general tariffs which ranged from 30-35% depending on the product.

Contrary to these intentions the new government decision sees tax on urea increased to 185% through to the end of September, then 175% through to the end of the calendar year; both up from the previous rate of 135%. A special 150% export tax was introduced for ammonium nitrate, up from 135%, while the duty on phosphate fertilisers was reduced to 120% from 135% for the duration of the December quarter.

JPMorgan says the increase in the urea tariff is a response to failure of existing tariffs to slow urea exports, exposing Chinese farmers to higher prices. The broker expects this new tariff level will see a reduction in Chinese exports, further tightening global markets and providing price support in a market where the year on year price was otherwise expected to decline.

Macquarie notes the urea export tax hike was expected and reflects the upward move in global urea prices, with prices in the Middle East, for example, up 96%. The broker thinks the tax increase may bring about a 5% fall in global supply.

The new tax rate on ammonium nitrate will also serve to keep Chinese product out of the market, Macquarie notes, serving to further tighten supply. This is especially positive for Orica. The stockbroker expects the company to get as much as $700/t in FY11 versus a legacy average contract price of $500/t, driving the broker’s double-digit earnings growth forecasts.

Currently, Macquarie rates the stock as a Buy, as do 7 out of 9 brokers on the FNArena database, while two have Holds. Macquarie is targeting a price of $28.84, which is close to (though still below) the FNArena target price average of $30.56.

Opinion is mixed on the impact of the tax rate reduction for phosphate fertilisers. Macquarie believes that while the tax rate is lower than the previous 135%, it will continue to limit Chinese exports. JPMorgan agrees, seeing the extension, not the slightly reduced rate, as the key. The broker predicts exports from China will still be slow and given that, pre-special tariffs, China accounted for 22% of global phosphate exports, price risk will still remain to the upside.

However, UBS differs somewhat, saying that a global inventory build-up and lower corn and other grain commodity prices have caused a pull back in global phosphate fertiliser demand in recent weeks. This, the stockbroker says, is likely to counter any short-term upward momentum and instead will see short-term pricing pressure to the downside.

One thing that all three agree on is that the medium to long term prospects for the fertiliser market remain strong, with UBS saying the relative strength of farm economics suggests fundamentals will remain intact.

JP Morgan is a little less reserved in its assessment, saying the revised Chinese tariffs are likely to provide positive support for prices, reinforcing its view that there is a buying opportunity in Incitec Pivot. It currently rates the stock a Buy, as do UBS and Macquarie. All in all, the stock rates a 0.7 on the FNArena sentiment indicator, with 8 Buys and 1 Sell from Deutsche. (Note: Deutsche Bank has been a non-believer in the Incitec story ever since the share price took off – it’s a valuation thing).

The JP Morgan, UBS and Macquarie target prices for Incitec are all in-line with the FNArena target of $190.93, ranging from $185- $195, with the full range on the FNArean database going from a low of  $110 to a high of $218.70.

Today, shares in Orica were trading 6.5c higher at 25.35, while Incitec Pivot was up $4.60 to $159.60 on the news. Shares have traded in a range between $22.60 to $32.50 and $66.37 to $200 respectively.

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