Australia | Nov 14 2012
– Incitec Pivot result viewed as better quality than that of Orica
– Earnings forecasts for both stocks revised lower
– Price targets also adjusted
– Buy ratings continue to dominate on both stocks
By Chris Shaw
Both Orica ((ORI)) and Incitec Pivot ((IPL)) have exposure to mining and explosives as well as agricultural fertilisers and both companies reported full year earnings this week, allowing for some comparison as to how each company is travelling.
Orica's profit result of $650 million pre-significant items was slightly short of most market forecasts, with JP Morgan singling out the Mining Services division as the key disappointment. Operations at Minova in the US in particular also continue to struggle, while ammonium nitrate volumes also weakened in the second half of the year.
As well, JP Morgan notes the result was boosted by some low quality items such as a lower tax rate and a higher profit on asset sales. This means the quality of the result also disappointed, as when adjusting for these items the result fell about 5% short of the broker's estimate.
Looking into FY13, JP Morgan points out the capex outlook for Orica has deteriorated, as $200 million has to be spent at Kooragang Island to improve environmental safety and controls. This will generate an increase in net debt in coming years.
Ammonium nitrate volumes are also expected to fall in the coming year, which has contributed to cuts to broker earnings estimates. BA Merrill Lynch has lowered its earnings per share (EPS) forecasts by 6-7% for FY13 and FY14, while Citi has lowered its FY13 estimate by 4%. Consensus EPS forecasts for Orica according to the FNArena database now stand at 197.1c for FY13 and 215.2c for FY14.
Despite the cuts to earnings estimates, Macquarie still expects Orica to deliver 13% EPS growth in FY13. In the broker's view this makes the stock cheap given current earnings multiples of 12.5 times for FY13 and 11.4 times in FY14. This is a discount of 7-11% to market when compared to long-term average multiples for the stock.
Others in the market agree, as post the result Orica is rated as Buy six times and Hold twice, with a consensus price target of $27.78. This is down from $28.84 prior to the profit result. Targets range from Citi at $26.60 to Deutsche Bank at $30.00.
Brokers are similarly positive on Incitec Pivot, as post that company's profit result the FNArena database shows five Buy ratings and three Hold recommendations.
Incitec Pivot delivered a net profit of $405 million, which was down 24% relative to the previous year. Such a decline had been anticipated and the result actually beat some forecasts, as for example Deutsche Bank had expected a profit of $386 million.
The result prompted JP Morgan to comment Incitec delivered a better quality result than Orica. A positive for JP Morgan was a write-back of Moranbah provisions, as this boosts earnings quality and transparency in the Dyno Asia Pacific business.
The move also has the effect of generating some large downgrades to consensus forecasts for reported earnings in FY13, something JP Morgan suggests is likely to put some pressure on the share price in the shorter-term. Any such weakness should be viewed as an opportunity in the broker's view.
In terms of changes to earnings estimates, JP Morgan's normalised EPS forecasts have been cut by 5-7% for FY13 and FY14, while BA-ML has lowered its numbers by 9% and 5% respectively. Consensus EPS forecasts for Incitec Pivot according to the database are now 24.5c for FY13 and 28.1c for FY14.
The outlook for Incitec's North American explosives business is improving, while Credit Suisse expects ammonium nitrate volumes can grow at mid-to-high single digits in coming years. This supports solid medium-term earnings growth expectations.
As well, UBS expects capex for Incitec will decline in coming years, so delivering strong free cash flow generation. This will continue to support what is already a strong balance sheet in the view of BA-ML.
A consensus price target for Incitec Pivot of $3.37 suggests reasonable upside from current share price levels, price targets for the stock ranging from Citi at $3.05 to BA-ML at $3.60.
Shares in Incitec Pivot today are stronger in a higher overall market and as at 12.00pm the stock was up 11c at $3.13. This compares to a trading range over the past year of $2.62 to $3.62 and implies upside of around 10% relative to the consensus price target in the FNArena databsae.
Orica offers around 17% upside to the consensus price target in the database and today is trading 5c lower at $23.80. Over the past 12 months Orica has traded between $23.01 and $28.27.
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