Incitec Pivot Running On Ammonia

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

-Project economics attractive
-But fertiliser market is weak
-As is explosives demand 
 

By Eva Brocklehurst

Brokers have sniffed ammonia in the wind as Incitec Pivot's ((IPL)) outlook hinges on the plant currently being constructed in Louisiana, US. The company dodged mounting challenges in FY15, delivering earnings growth of 11%, with fertiliser a key contributor as production volumes at Phosphate Hill stabilised, while the weaker Australian dollar lent a hand.

The company has confirmed its Louisiana facility is on budget and on track for first production in September 2016. The project economics remain attractive, brokers believe, as weakness in global ammonia prices is offset by a sharp fall in US gas prices. To Citi, despite the challenges in the company's end markets, this project and the potential cash flow is what the game is all about.

The underperformance of the share price following the results announcement is driven by the cautious outlook management offers, JP Morgan maintains. In particular,  with regard end markets for explosives in both the Americas and Asia Pacific. The domestic fertiliser distribution market also faces heightened competitive dynamics.

Still, JP Morgan remains positive on the stock, given the Louisiana commissioning will mark an end to a long period of elevated capital expenditure and generate a significant increase in cash flow.

Credit Suisse considers the company executed well in FY15 in the face of difficult markets for explosives and fertiliser. A tailwind from the Australian dollar helped, admittedly. The broker notes the company's improved disclosure allows the inclusion of a derivative offset to foreign currency denominated debt in its valuation for the first time and upgrades its rating to Neutral from Underperform.

The broker acknowledges that nitrogen and phosphate market fundamentals will become more difficult in the near term, and only correct on the back of additional supply cost inflation. Meanwhile, explosives earnings are not expected to improve in the near term as coal fundamentals remain weak.

The outlook is fraught, in Morgan Stanley's view, with an Underweight rating upheld. The broker maintains that core earnings drivers are deteriorating, overshadowing the falling currency and the upcoming start of the Louisiana plant. The broker expects downgrades to consensus earnings expectations will be forthcoming across FY16-18 and place pressure on the stock.

The pressure on the explosives industry is structural, Morgan Stanley also contends. Ammonium nitrate (AN) demand may now be in a permanent state of decline, as global growth shifts and pressure builds on bulk commodities and metals. Longer term, the broker surmises, new technologies have the potential to displace explosives and reduce bulk commodity demand. Meanwhile, supply of AN continues to grow.

On the fertiliser front, conditions are also weak and the broker expects the El Nino weather pattern in the Pacific will result in poor agricultural conditions in Australia in FY16. The risks for both urea and diammonium phosphate (DAP) prices and volumes appear biased to the downside. Morgan Stanley expects the economics of the Louisiana plant, while screening well, will offer little offset to the weakness until at least FY17.

With management commenting that it will pursue capital management, Morgan Stanley incorporates a $500m buy-back across FY17-18 ,with the impact largely offset by increased net interest costs. Macquarie estimates a 10% buy-back would be 6.0% accretive at the current share price and considers November 2016 the most likely timing for such an announcement.

Macquarie also considers the positives outweigh the negatives and believes Louisiana should drive a step-change in earnings and related cash returns to shareholders. The main earnings growth driver in FY16 is likely to be the weaker Australian dollar, and one quarter's contribution from Louisiana. Earnings growth is then expected to accelerate to 37% in FY17 as Louisiana contribute for a full year.

The broker acknowledges that fertilisers were weak in FY15 but cites the company's expectations of a partial improvement in margins, given urea stock levels are back to normal. That said, Macquarie concurs that the El Nino development makes guidance for volumes optimistic but also believes the impact is likely to be small.

The outlook may be challenging but for Deutsche Bank the key earnings drivers are intact while UBS also finds value in the medium term as the stock offers an annual free cash-flow yield of 12% and a 5.0% dividend yield on forecasts two years out.

The result was weaker than Morgans expected, the market conditions challenging and earnings forecasts have been revised lower. Still, the cash cow promised at Louisiana and the prospect of capital management keeps the broker on a Hold rating.

FNArena's database contains five Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $4.20, suggesting 14% upside to the last share price. Targets range from $3.45 to $4.50. Thedividend yield on FY16 estimates is 3.6% and on FY17 5.1%.
 

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