Incitec Pivot: Fertilisers Weak, Explosives Supportive

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

-More reliable production
-Fertilisers weather affected
-US recovery the main positive
-Risks with Aust gas supply
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) remains vulnerable to weather conditions but whatever the weather there are positives and negatives. A recent investor briefing delivered a softer assessment for fertilisers in FY14, with the company's year-end occurring this month. Still, brokers were relieved that both the Moranbah and Phosphate Hill plants are now operating more reliably.

Fertiliser tonnage in FY14 will be lower, a negative, with the company expecting 1.8mt versus the 2.05mt in FY13. There have been lower urea sales at lower domestic prices, as inventory was built up ahead of the recent commodity price rally. Nevertheless, the wet weather that affected fertilisers should assist the mix of emulsion volumes versus bulk ammonium nitrate, which should allow Moranbah to deliver earnings at the top of the forecast range.

There is also some softness in the Western Australian explosives market, with the mining downturn more challenging for the company than previously assumed, and Phosphate Hill production is likely to be at the lower end of guidance. Deutsche Bank observes the company is primarily a distributor in Western Australia and margins are being squeezed as the major supplier Wesfarmers ((WES)) increases prices to recover higher gas costs. Incitec Pivot is not able to pass these costs so easily through to customers as there is now surplus capacity, given Wesfarmers' expansion and the fact Orica ((ORI)) has recently entered the market.

The US construction recovery continues to underpin the stock, although the company has warned of a slower rate of recovery for FY14, while trading conditions in other explosives markets are still soft. The US market has a positive position on gas costs and the structure of the ammonia market which should stand Incitec Pivot in good stead. Citi notes the medium term outlook for ammonium nitrate is weaker as growth expectations for the next five years have been lowered in all markets. The desire of miners to continually reduce costs will not go away and this is exerting pressure on explosives suppliers.

Australia is where the risks mostly lie, and where the next key decisions are likely to be made. Brokers are reminded of the risks to the Australian fertiliser business beyond the current gas supply arrangements. The company's objective is to offset the impact of gas cost increases at Phosphate Hill through plant reliability and improvement initiatives. Credit Suisse suspects Gibson Island production is at risk beyond when the current gas supply agreement ends in 2017. A strategic review of some assets is being undertaken, namely Nitromak, Fabchem and SSP manufacturing assets, and may result in write downs, but Credit Suisse does not believe this will be material to the outlook.

Deutsche Bank also notes the outlook was soft, with Phosphate Hill production expected to be at the low end of prior guidance. On the positive side, the Louisiana plant is on budget and North American explosives volumes are improving. On the negative side, fertiliser distribution volumes are likely to be lower by 10% and the Dyno Nobel Asia Pacific explosives market remains challenging.

Macquarie notes earnings downgrades are becoming a perennial theme for Incitec Pivot, but acknowledges most of the downside is in fertilisers. Moreover, this is a lower value area for Incitec Pivot and seasonal variances are outside management's control anyway. What is important is the company is on top of the internal issues and Moranbah is now likely to sustain nameplate production. Macquarie analysts admit to feeling better about the company's manufacturing performance and the risks than was the case six months ago.

The company is maintaining a strategy which should ultimately enhance shareholder returns from FY17, in Citi's view. While the market is expected to look through the near-term softness, Citi believes the catalysts are limited. Credit Suisse expects cash generation to improve significantly from FY16 and the company could move to a period of increasing capital returns to shareholders.

CIMB found management's tone bearish, but the downgrades were not a great surprise, with the key divergence from prior forecasts being a deterioration in operating conditions in fertilisers from particularly subdued cropping conditions. Both Goldman Sachs and CIMB welcome the company's confidence in the fact that the Louisiana ammonia project will capitalise on the divergence between US natural gas and global ammonia prices to achieve a 15% internal rate of return but neither broker is carried away. Both consider the stock is fairly priced. On FNArena's database there are three Buy and five Hold ratings. The consensus target price is $3.15, suggesting 6.4% upside to the last share price. Targets range from $2.81 to $3.27.
 

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