Incitec Pivot Lifts Confidence In Louisiana

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

-Cash flow steps up
-Capital management?
-US now the mainstay
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) has enhanced confidence in the outlook at the Louisiana ammonia plant being constructed in the US. The company updated North American investors with a tour of the plant and those brokers present welcomed the chance to update forecasts and expectations. Confidence in timing, costs and outlook has improved.

UBS finds Louisiana compelling, raising earnings forecasts for FY16-17 by 5.0% to incorporate the initial contribution from Louisiana ammonia in the September quarter next year. FY15 estimates are also raised, by 3.0%, to reflect higher Phosphate Hill volumes. UBS previously assumed a drag from the Dyno Nobel explosives business but the presentations highlighted the strong position it holds in its key end markets.

Major capital expenditure is now largely complete at Louisiana and net debt has peaked. The company appears set to generate annual free cash of around $700m per annum which, all else being equal, suggests to UBS the potential for capital management by the end of FY16.

Any negatives are reasonably well known, in Deutsche Bank's opinion. The company is also highly leveraged to the depreciation in the Australian dollar with every US1c move down enhancing pre-tax earnings by around 1.7%.

The negatives are mostly surrounding Australian business, with pressures on volume and margin in explosives and lower gas supply at Moranbah. The company has expressed confidence that the reduction in gas supply to Moranbah should not persist beyond 2016.

In terms of explosives, the company believes the effect of the mining downturn should be limited, as explosives are just 5.0% of total mine production costs. Nevertheless, Deutsche Bank suspects reduced demand for higher value products and services will have an impact, as this has been a provider of earnings growth over the past five years.

In contrast, the North American market is still short on ammonia and gas is in abundance. Macquarie observes Incitec Pivot has first mover advantage in terms of cost, risk and time in the ammonia market and is well positioned to capture the gas-to-ammonia arbitrage.

Coal production in North America declined in the second half, impacting the explosives business. Despite this, Macquarie highlights the company's forecast for Dyno Nobel US dollar earnings to be roughly in line with the prior corresponding half. This should be achieved via cost cutting and price rises in ammonium nitrate.

The Dyno Nobel exposure to US end markets is in the coal, mining and quarry & construction segments. While headwinds from coal and mining are well known, the company remains more optimistic about quarry & construction. Strong growth is expected on the back of road and infrastructure projects.

Nonetheless, the Louisiana earnings contribution is expected to be the main driver of the outlook for the company, with the variables being natural gas and ammonia prices. Macquarie calculates, even when including the decline in global prices for both natural gas and ammonia – which are linked to oil, the economic proposition at the facility still compares favourably.

Citi was reassured by the update, believing the main variables that surround the Louisiana plant were comprehensively addressed. Structural issues should keep the US market dependent on imports and this supports the market economics, in the broker's view. With gas prices likely to be lower for longer this makes the project highly attractive, with Citi estimating a 4-year pay-back.

Citi also suspects a capital return might come sooner than is widely expected. Of note, the US explosives business has faced material volume and cost pressures but, brokers believe, this has been broadly offset by higher average prices and efficiency programs. Incitec Pivot will become heavily leveraged to the US, with 50% of group earnings and two thirds of cash flow after FY17 emanating from that region. 

FNArena's database has four Buy ratings, one Hold and two Sell. The consensus target is $4.15, which signals 12.4% upside to the last share price.
 

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