Reliability Issues Weigh On Incitec Pivot

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

-Company needs to improve confidence
-Depressed DAP prices hinder outlook
-Questions over plant capacities
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) has tested brokers' resolve with more production problems at Phosphate Hill. While ratcheting down earnings forecasts for FY13, they are mostly prepared to forgive, again.

This is the third outage in as many years at the Phosphate Hill plant and has been attributed this time to the failure of the iso-thermal shift reactor, which scrubs carbon out of the gas feed. The plant will not be back on line for a week and will operate at 50% capacity for the following two weeks. The prior outages pertained to the sulphuric acid plant. The company also experienced production interruptions recently with the newly commissioned ammonia plant at Moranbah and has had to address the damage. Production and earnings guidance for Moranbah was subsequently reduced to 200,000 tonnes and $56m for FY13 from 250,000 tonnes and $90m respectively.

The latest Phosphate Hill production problems are expected to reduce the second half's manufactured diammonium phosphate (DAP) by 110,000 tonnes and deliver a $23.5m reduction to the FY13 profit. CIMB believes this impact from the incident is modest and should not be capitalised, but the track record is a concern. This may be a one-off but it raises questions for brokers about the capacity to execute on expectations.

Credit Suisse maintains the short term priorities must be about improving manufacturing capabilities, along with issue at Moranbah which have delayed the ramp up. If the company is successful it should improve earnings predictability and the market's confidence in the company's capacity to execute. CIMB also questions the real capacity of Phosphate Hill, but acknowledges the company is reviewing the manufacturing processes.

Ratings might then improve. As it stands, on the FNArena database there are two Buy ratings and six Hold. This compares with competitor Orica ((ORI)), which has four of each. The consensus target price on the database is $3.16, suggesting 17.2% upside to the last share price. The target has slipped from $3.28 before the announcement. The dividend yield is 4.4% for FY13 consensus forecasts and 4.8% for FY14.

The $23.5 million impact to the bottom line is based on a DAP price of US$470/t and AUD/USD rate of US92c. For Credit Suisse, this implies that fully absorbed costs at Phosphate Hill have increased by 13%. This should normalise when the plant ramps up but, given the frequency of outages, the broker wonders whether nameplate capacity and longer-term assumptions shouldn't be revisited. Operational issues are weighing on the share price near term but the broker has identified many catalysts that can drive the stock towards the $3.25 valuation. This could be via improving utilisation at Phosphate Hill and Moranbah, favourable fertiliser prices, the falling Australian dollar and rising US gas prices – to name a few.

Deutsche Bank has reduced FY13 and FY14 earnings forecasts by 3-10% to take account of the outage as well as slightly lower global fertiliser price assumptions. Global fertiliser prices are in decline, with DAP at US$458/t and urea at US$323/t currently. The DAP price has been affected by soft demand from India and increasing supply from China and Saudi Arabia. Urea's price has been affected by weak demand and increasing supply from China and the Middle East. Macquarie thinks fertiliser prices may have found a bottom but they remain weak and are expected to continue being a drag on earnings. CIMB has reduced FY14 DAP price forecasts to US$475/t, taking into account the 5% decline in the benchmark Tampa price that has been seen for the year to date.

Production reliability is an ongoing issue for the last 12-18 months and Macquarie has reduced FY13 and FY14 earnings forecasts by 9% and 3% respectively. This relates to lower earnings for Dyno Asia Pacific as well, in the light of tougher gold and nickel markets and a more challenged margin environment. Macquarie is encouraged by some progress being seen at Moranbah but feels this has to be seen to be maintained to improve confidence. 

UBS also thinks a successful ramp up at Moranbah is critical to an overall re-rating of the stock and has incorporated more conservative production and cost related assumptions for the DAP business. The broker finds the stock's valuation attractive, but catalysts such as a recovery in fertiliser prices and the explosives markets are not expected until late next year. CIMB maintains a Neutral stance but is concerned about the impact of the upcoming gas supply contract rollover on profitability, coupled with the subdued DAP price outlook. Incitec Pivot and Orica are trading at relatively similar FY14 multiples but at this stage the broker prefers Orica. 
 

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