Treasure Chest: Consensus Overvaluing Orica?

This story features ORICA LIMITED. For more info SHARE ANALYSIS: ORI

By Greg Peel

Explosives producer Orica ((ORI)) is enduring challenges in its key end markets, notes UBS. Coal prices are particularly weak at present, and coal mining accounts for some 35% of Orica’s sales. The company’s guidance for FY15 earnings being flat on FY14 relies upon a skew to the second half, and weakness in higher margin Australian demand suggests to the broker this skew will likely not be as significant this year.

Orica has addressed the downturn by reducing capacity at several of its ammonium nitrate production facilities in response to a potential crisis of oversupply, and this should result in a more balanced market through FY20, UBS suggests. However Australia represents around 55% of earnings, and Australian miners are now heavily focused on managing costs in the near term, and long term investment in commodities such as coal is lacking.

To that end, UBS has cut earnings forecasts by around 10% across FY15-17, now seeing a mere 3% per annum growth rate over that period. Despite below-average growth, and a greater scope for earnings disappointment, Orica is trading on an FY16 forward PE of 12.5x, in line with the Australian Industrials ex-Financials multiple.

UBS maintains a Sell rating on Orica and has reduced its target price to $17.50 from $19.00, representing an FY16 PE of 11x, which is in line with Orica’s historical average 15% discount to market. The broker further notes that despite a material reduction in capex expected over the next few years, Orica offers only a 5% FY16 yield, in line with the All Industrials average yield.

Macquarie (Underperform) and Morgan Stanley (Underweight) are also negative on Orica while Deutsche Bank (Buy) remains keen on the stock. The three other brokers in the FNArena database covering the stock have Hold or equivalent ratings.

Morgan Stanley warns Orica is facing more issues ahead than just a weak coal market. While the company boasts of its diversified commodity, product and geographical profile as a benefit, Morgan Stanley notes such diversity can also lead to headwinds that would not be felt in a simpler structure. Orica's significant exposure to US dollar-denominated gold producers in North America, Asia and Africa are likely to pose an increasingly challenge, the broker suggests, alongside the company's exposure to US coal.

The recent, rather rapid plunge in the USD gold price to around the 1100/oz mark from the 1200/oz mark will put gold miners under further pressure, ahead of ongoing US dollar strength and subsequent gold price weakness expected from the upcoming Fed rate rise which at this point is considered quite possible as soon as September.

The consensus price target for Orica in the database sits at $19.74, but UBS’ new target of $17.50 is by no means the low marker in the database. Morgan Stanley has set a target of $14.07.

Note that Orica’s financial year ends in September, thus the company is not among those reporting earnings next month.
 

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