Incitec Pivot Sewing Seeds For Growth

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

By Andrew Nelson

Explosives and fertiliser maker Incitec Pivot ((IPL)) beat market expectations with its FY09 result and shares rallied 6.5% yesterday as investors warmed to the result. However, stockbrokers were a little more restrained in their enthusiasm, with several questioning the overall quality of the result and all remaining fully aware that 2010 will be another tough year for the company.

The company did not provide any guidance, however, it expects business conditions to be soft, particularly in the first half, given currency, global fertiliser demand, and seasonal conditions in North America.

Chief executive James Fazzino confirmed that 2010 will be another challenging year, although he felt the company was now better prepared to face the challenges ahead. He said he was confident the company is much better placed than it was 12 months ago “because the business is a lot fitter.”

Fazzino went on to say that the long-term strategy, which gives the company the ability to mix and match its chemical plant capacity to both fertilisers and explosives for the mining industry, depending on where the demand is, will give the company the best possible exposure to both minerals and food production.

All up, the company booked a loss of $179.9 million for the 12 months to September 30, compared with a profit of $604.6 million in the year prior. The loss was well expected given a number of warnings during the year on the back of falling world fertiliser prices and as the mining industry progressed further into the current slowdown.

The result was, however, overshadowed by a $491m write down on the Dyno Nobel explosives business. Still, net profit excluding material items fell 46%, although revenue was up 17%, helped by the first full-year contribution from its acquisition of Dyno Nobel, which the company bought in 2008.

The top-line result came in above RBS Morgan’s forecasts, however the broker notes that the quality of the result wasn’t great. Among its laundry list of issues, Morgans cites a lower effective tax rate, a questionable phosphate rock write down below the line, while the top line result also included an $18.4m boost from a Moranbah provision relating to contract losses that were previously recognised. Take these out, and underlying earnings actually came in below the broker’s forecasts.

That said, RBS Morgans admits that the “broad themes” were in line with its expectations. It notes, of course, lower fertiliser prices, reduced margins, lower volumes due to a delay in the buying season, unwilling farmers and a weak 2H09 showing from Dyno. Otherwise, the broker notes that Dyno goodwill was written down by $490m, while the balance sheet remains in good nick, with $943m of headroom.

Analysts at Deutsche Bank were also disappointed by the result quality, citing the same reasons as Morgans, while also noting that FY10 has not started well. DAP prices have fallen to US$280/t  and explosives volumes are down 10-20%. North American coal production is also down 10% and the broker says it sees no signs of improvement in quarry and construction demand.

Deutsche also thinks the size of the Dyno Nobel write down is pretty solid proof of the challenges the company is facing in delivering the expected benefits and returns from this acquisition. Management had guided for an 18% return on the acquisition asset base, which adds up to US$204m in savings. Yet while the guidance was maintained, management has now delayed the timing of these benefits by 12 months to 2012.

The stock is rated a 0.2 on the FNArena Sentiment Indicator, which is based on 4 Buys, 3 Holds and  2 Sells. Deutsche is unsurprisingly one of those with a Sell, while Morgans has a Hold on the stock.

Yet there are three other brokers in the FNArean database with opinions on the result. They are UBS, JP Morgan and Credit Suisse and these three have all maintained their Buy calls on the stock. Unsurprisingly, their collective reaction to the result was a little more upbeat than what we’ve discussed so far.

JP Morgan sees the company as being all about global fertiliser prices and, in particular DAP prices. The broker is expecting to see improved prices in the December-March period as the North American and European fertiliser build gathers pace. With farmers having reduced their usage rates in 2009, the broker thinks that demand will almost have to rebound in 2010. And with inventories at five year lows, the broker thinks this is a potentially powerful force for prices.

Given this view, JP Morgan sees solid valuation support for the stock even under a fairly bearish fertiliser price scenario. However, the broker says that when factoring in its more positive outlook, the upside for the stock should be “material”. Thus the broker believes that investors should position for this prior to the lead-up to the US and European seasons.

The result actually came in a little bit below UBS, but the broker thinks that some good cost and capex management during FY09 has set the business up to leverage the upside it sees in the DAP and Urea fertiliser markets. While the broker admits the strong AUD and breakdown in correlation with DAP pricing remains a risk, it notes management has hedged 50% of its USD fertiliser revenue at 89c.

With the company trading at 10% discount to its weighted average peers like Orica and other major fertiliser companies, even using conservative fertiliser assumptions, UBS much like JP Morgan, sees significant upside when markets come out of the current seasonally weak quarter.

Credit Suisse offer us the most upbeat assessment. First, the broker notes fertiliser earnings were a little above its expectations. Explosives exceeded the broker, which it calls “commendable” given underlying volumes fell 14%. CS admits that the result quality was a bit iffy given the same reasons cited by Morgans and Deutsche, but much like UBS and JP Morgan, the broker sees some real upside as soft commodities begin to improve.

Apart from being optimistic about fertiliser prices, CS also predicts that North American explosive volumes should start to recover, while local ammonium nitrate prices are also set to firm. Credit Suisse also sees upside eventually coming from the achievement of the Dyno Nobel synergy target and it isn’t that worried about this being pushed back to 2012, as the broker never thought it was in the price in the first place.

As at 11:36 today, shares were flat at $2.79 versus a 12-month trading range of  $1.63 to $3.42.

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