Treasure Chest: Incitec Dividend Growth Not Appreciated

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

By Greg Peel

Back in May when fertiliser/explosives producer Incitec Pivot ((IPL)) released its first-half profit result, only two FNArena database brokers carried Buy or equivalent ratings on the stock. Expecting the contribution of Incitec’s Australian business, as opposed to its US business, to decline further, Credit Suisse downgraded to Underperform.

That made two Sell or equivalent ratings to three Holds and two Buys.

The result was poorly received on the day, although as UBS pointed out, the “miss” was a lot to do about the timing of profits booked. The broker’s Buy rating is predicated on the value of Incitec’s Louisiana fertiliser plant project and the cash it will generate once production begins next year.

Macquarie’s Outperform rating is based on the same theme. Incitec has endured a long period of intense capital expenditure, Macquarie noted this month, but with the local Moranbah fertiliser plant now up and running and Louisiana about a year away, the broker sees FY17 as the year the spending stops and the cash starts to flow.

Macquarie suggests such cash flow provides the opportunity for increased dividends and/or share buybacks.

Citi retained a Neutral rating at the time of Incitec’s result release, but has now upgraded to Outperform. Concurring with Macquarie, Citi believes the opportunity for capital management ahead is being under-appreciated by the market.

Incitec’s strategy to increase shareholder returns has moved on from the company’s 2006-08 M&A stage, which saw Southern Cross and Dyno Nobel acquired, to the 2011-16 internal investment stage, which will include the construction of both the Moranbah and Louisiana plants. Thereafter, Incitec will move into a free cash flow stage.

The quality of these cash flows should not be underestimated, Citi entreats. The broker estimates Incitec’s cash flow conversion (into earnings) will average better than 95% over FY15-18. This should enable the company to deliver a capital return that is both earlier and bigger than the market currently expects. Louisiana will provide a material step-up in cash flow and Citi suggests a share buyback of up to $750m could be on the cards.

The timing is uncertain at this stage, but Louisiana is presently on time and budget for a mid-2016 start-up.

Citi believes that while the market understands the potential earnings contribution from Louisiana, it does not fully understand the cash flow implications. A combination of a post-Louisiana PE of only 11x, a free cash flow yield of 9%, a dividend yield of better than 4% and a potentially higher than anticipated capital return (in the form of a buyback) makes for a compelling investment case, Citi argues.

Following Citi’s rating upgrade, the FNArena database now shows three Buy or equivalent ratings, two Hold and two Sell. Citi’s target price increase to $4.45 from $3.80 takes the consensus target price to $4.09.
 

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