Louisiana Is Pivotal To Incitec

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

-Weakness in fertilisers & Asia Pacific
-North American outlook brighter
-Upside from Louisiana start up
-Potential returns to shareholders?
 

By Eva Brocklehurst

Incitec Pivot's ((IPL)) first half may have been better than many brokers expected, but interpreting the outlook hinges on what emphasis is placed on the various parts of the fertiliser and Dyno Nobel explosives business.

Growth in half-year earnings was assisted by improved diammonium phosphate (DAP) income, on higher prices and volumes, along with a lower Australian dollar rate and reduced interest and taxes. That said, core weaknesses in fertilisers and Asia Pacific explosives have caused many brokers to pull back FY15 forecasts. FNArena's database reflects this diversity, with two Buy ratings, four Hold and two Sell. The consensus target is $3.88, suggesting 2.4% upside to the last share price.

Morgan Stanley acknowledges the business is volatile, dependent on fertiliser pricing and the explosives demands of miners, but believes the risks are to the downside. This is despite the promise of a leg-up in earnings when the Louisiana plant in the US comes on line in FY16. The broker is preoccupied with the distribution margin weakness, which frustrates otherwise positive trends such as the benefit of a weaker Australian dollar. The emergence of new production problems at Gibson Island is another headache.

The broker suspects the earnings upgrade cycle has come to an end and a volatility discount is developing in its place, as investors struggle to set a value for operations. Morgan Stanley had believed production issues were behind the company after Phosphate Hill was sorted but now Gibson Island is expected to run at 85% capacity until a fix is completed in March 2016. The broker also complains that despite management stating the Gibson Island issues were known, it was not pointed out in FY15 guidance provided last November. Moreover, a substantial increase in gas costs at Phosphate Hill in the second half could pose challenges to cost targets by the end of FY15.

On the explosives front, operations have been considered a defensive offset to the volatility from fertiliser income. Morgan Stanley has not subscribed to this view but was surprised, nonetheless, by the weakness in Dyno Nobel Asia Pacific. As market conditions are expected to deteriorate the broker retains an Underperform rating. Deutsche Bank also believes the outlook has deteriorated in terms of fertilisers, as well as explosives in the Asia Pacific region. Forecasts are reduced by 2-6% to reflect lower earnings from fertilisers – specifically Gibson Island production – and explosives – reflecting Western Australian services, Indonesia, Turkey and US coal.

Citi remains a holder of the stock because of the approaching step-change in earnings and growth with the start-up of the Louisiana ammonia plant. In the meantime, the broker considers the balance of risks more even than earlier in the year when the share price rose sharply on the back of FX-linked forecast upgrades. The shares may be 16% below April highs and positive catalysts are unlikely to be repeated, but Citi suspects consolidation is likely until the investor tour of Louisiana occurs in September.

On that note Morgans is far more optimistic. A weaker Australian dollar and manufacturing excellence should be supported by the new Louisiana project and underpin solid earnings growth in coming years. The broker recommends shareholders hold on for improved returns. The first half may have missed forecasts because of weakness in fertilisers and Asia Pacific, but overall growth reflected increased volumes at Phosphate Hill and Moranbah, a lower Australian dollar and higher DAP prices.

The broker was also pleased with the North American explosives business, which was better than expected because of margin improvement and price increases, despite total ammonium nitrate (AN) volumes falling on the back of weaker coal and metals markets. In the near term, the stock is considered fair value and Morgans retains a Hold rating.

Various offsetting factors cause UBS to keep forecasts unchanged for FY15-17. Reductions in Australian fertiliser earnings from weaker distribution margins are offset by higher Dyno Nobel earnings which reflect better outcomes in the North American explosives business. The broker also assumes DAP strength should prevail, with sustained improvement in the operations of Phosphate Hill. UBS expects around 20% compound growth in earnings over the next two years upon a lower Australian dollar and completion of the Louisiana plant, as well as some turnaround in fertiliser distribution margins.

Credit Suisse downgrades to Underperform from Neutral, largely because of the appreciation in the share price. The broker also believes the future is in the US ammonia business, offering a solid investment case, admittedly supported by current gas and ammonia prices. The contribution from the Australian explosives and fertiliser segments is likely to decline further, in the broker's opinion, as a result of a contraction in the value chain of bulk AN production and worsening fertiliser economics. Valuation support for the stock, therefore, depends on US ammonia earnings. From this perspective cash flow is seen improving from FY17, raising the probability that returns to shareholders will be increased through capital management.

Macquarie, too, likes the look of the Louisiana investment case. The plant remains on track in terms of timing and budget and is expected to drive a step up in earnings and cash returns to shareholders via dividends or buy-backs. The broker also found the retention of flat US dollar profit guidance for Dyno Nobel Americas a positive, given the deterioration in coal markets. The outlook reflects net margin benefits from renegotiated contracts and accelerated growth in quarrying & construction. The two disappointments for Macquarie were the domestic fertiliser and Dyno Nobel Asia Pacific businesses.
 

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