Leverage The Key To Incitec Pivot

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

-Constraints from weak crop, mining
-Long term value in diversity
-Upside from Louisiana ammonia plant
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) may have rallied in the wake of the FY14 results but in coming days a more sober analysis is likely to mean some of those gains are relinquished. This is JP Morgan's observation after the profit result for the explosives and fertiliser business turned out better than many had expected, as did the final dividend. Nevertheless, management's outlook is for a flat explosives market in FY15 and lower earnings from agriculture.

JP Morgan expects a weak outlook for both Dyno Americas and Dyno Asia Pacific will result in eventual downgrades to consensus forecasts. Goldman Sachs, too, considers management's FY15 guidance is cautious, with explosives earnings expected to ease and the contribution from Moranbah's revamp less than the broker expected. Goldman retains a Neutral rating but considers Incitec Pivot one of the most leveraged domestic industrial stocks to a lower Australian dollar and US economic recovery, which should attract investor attention over the ensuing twelve months.

At an operating earnings level, Incitec's FY14 result was up 10% on FY13 and all businesses delivered growth in Australian dollar terms, underpinned by the ramp up at Moranbah, cost cuts and currency translation. Long term value lies in the company's diversity across explosives, fertiliser and ammonia assets but this does not provide enough to support the current share price, in Morgan Stanley's view. Deteriorating explosives market conditions could also be a source of additional downside. The attractiveness of the stock is all relative for the broker – the defensive position at Moranbah offsets deteriorating explosives markets, while the Louisiana ammonia plant is positioned to deliver material earnings growth from FY17. These opportunities are not available for the company's closest peer, Orica ((ORI)), and in that way also, the value is relative.

Morgan Stanley considers the stock is modestly overvalued with efficiencies, fertiliser and FX being the swing factors. The broker retains an Equal-weight rating. Despite rising gas costs the company still offers significant leverage to diammonium phosphate (DAP) and urea prices and would be a beneficiary of any further weakness in the Australian dollar.

Macquarie observes the big ticket items such as Moranbah's revamp and the development of the Louisiana ammonia plant are on track and increasingly important. Louisiana will enable Dyno Americas to be far more cost competitive. Improvements in manufacturing in FY14 also heartened the broker. The outlook for Dyno Americas remains mixed. A number of contracts were renewed in the last twelve months and, while some were retained, geographic cost differentials and higher ammonia sourcing costs put paid to others. Macquarie notes the outlook for DAP prices suggests some recovery is in train, but remains unconvinced prices will move higher immediately. Buyers are reluctant to engage while the market is weakening and this suggests a floor may not yet be reached.

Citi is supportive of the Louisiana ammonia project, despite constrained near-term earnings. Nevertheless, fertiliser markets are pressured by subdued pricing while mining activity globally is suppressed, the broker suggests. The main advantage in the Australian dollar's downturn is in domestic fertiliser reference prices and the translation of foreign earnings, in the broker's view. Still, the crop outlook will constrain performance despite the long-term positives. UBS points out one area of weakness in the results was cash flow, with earnings conversion weak because of the build up in inventory, reflecting a re-basing of working capital going forward.

Guidance was a little softer than UBS expected, but broker believes the stock screens well on relative value and long-term cash generation. Moreover, UBS considers execution risks around plant reliability are diminishing and, with Louisiana offering attractive metrics on spot price assumptions, the stock could be ready for a positive re-rating. Hence, a Buy rating is retained. Morgans is also more buoyant, believing the company offers compelling growth opportunities. While short term operating conditions are challenging and Louisiana's "pay day" is not likely until FY17, when the plant comes on line, the broker maintains a Hold rating.

To Deutsche Bank the trade-off from challenging mining and agricultural markets is the improvement in manufacturing and productivity. Still, the broker is wary of the recent decline in soft commodity prices, particularly as a period of lower fertiliser demand is ahead. The broker reduces earnings forecasts by 3-5% and believes Incitec Pivot will continue to rationalise operations but notes the scope is limited and the impacts one-off in nature.

Ratings on FNArena's database have been consistent for some time. There are two Buy and six Hold ratings for Incitec Pivot. The consensus target is $3.17, signalling 5.7% upside to the last share price. Targets range from $2.80 (Morgan Stanley) to $3.30 (Deutsche Bank).
 

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