Resilient Incitec Pivot Surprises Brokers

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

-Poor outlook for phosphate market
-Louisiana on track for end 2016
-Signals potential capital return
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) surprised most brokers with its first half results, as the impact on earnings from the Dyno Nobel Americas volume losses in the coal and metals markets was less than expected. Moreover, the company impressed with record production from its Australian Moranbah and Phosphate Hill plants.

Even with the low-quality items, such as stock elimination and lower net interest, taken out of the equation the first half was stronger than Morgans expected. This is due to an impressive result from Moranbah and the North American explosives outcome. A clear tailwind is the lower Australian dollar, although the broker concedes this will diminish in the second half, given the material decline has now been cycled.

The broker welcomes the new efficiency program that is expected to deliver $80m in cost savings and $20m in capex savings by the end of FY17. FY16 may be a challenging year but Morgans expects earnings growth to return in FY17, as the Louisiana ammonia plant ramps up. Based on the broker's forecasts the stock is trading in line with its global peers.

No formal earnings guidance was provided, and given the uncertainties, the company's outlook comments were the lightest in years, Morgans adds. The potential for further declines in coal volumes in the US and pressure on Australian coal markets was flagged, as well as lower fertiliser prices. All up, the broker remains a happy holder of the stock.

Approximately half of the lost volume in the US market appears to reflect underperforming contracts, from which the company decided to walk away. This is validated, Credit Suisse maintains, given the average margin loss was only US$46/t. Hence, the impact on the bottom line is less severe.

Credit Suisse observes cost reductions have accelerated, to help offset more difficult market conditions. On the other hand, the outlook for phosphate markets is considered poor and no recovery in di-ammonium phosphate (DAP) prices is expected until FY19. Still, the broker forecasts $420m in free cash flow in FY17 and FY18 and allocates $240m to capital management in each of those years.

Morgan Stanley considers the results messy, significantly affected by the decision to impair Gibson Island, raising the prospect the plant could be loss making from September 2018. Nevertheless, underlying earnings beat this broker's estimates as well.

On a deeper level, Morgan Stanley notes that this was entirely driven by a $32m favourable movement in stock clearance and, without it, earnings would have missed forecasts by 9.0%. The broker surmises that this benefit will disappear in the second half and, given the headwinds, consensus earnings estimates for FY16 may need to fall by as much as 10%.

What is most important is that the Louisiana plant is on track, Macquarie asserts. The project is now 97% complete and on budget. The write down of Gibson Island was not a surprise, given the prohibitive gas costs currently on offer and Macquarie, having phased down profit estimates in FY19/20, now reduces this to zero.

 A solid balance sheet and capital management potential has been reiterated and the explosives business appears resilient, leaving the broker with a positive outlook.

Ord Minnett is of a similar view, given the challenging markets, and believes the company has executed well on the variables within its control. Phosphate Hill and Moranbah are producing at record levels and explosives margins for Dyno Nobel Americas have improved as a result of efficiencies.

Deutsche Bank raises earnings forecasts by 6-12% to reflect higher Southern Cross and Australian explosives earnings as well as lower net interest expenses, partly offset by lower US explosives earnings.

The broker flags the benefit from recent rainfall on the east coast of Australia for fertiliser consumption and for North American quarry & construction (Q&C) volumes, with the passage through the US Congress of the 5-year US$305bn highway bill. The company expects Q&C volumes to increases by 1-2% plus GDP per annum over the next five years.

The broker notes the company is seeking to return capital upon production being deemed reliable at Louisiana, the timing of which is expected to be late 2016 early 2017.

UBS found the results credible, given the challenges, and raises earnings estimates by 13% for FY16 and 8.0% for FY17. The highlight was the explosives businesses in Australia, which indicates the favourable position that Moranbah has in the market, and in North America, where the Dyno explosives earnings fell just 4.0% despite an 18% drop in volumes, led by significant declines in coal-related ammonium nitrate demand.

This result demonstrates to UBS a focus on costs but also the company's limited earnings exposure to US coal end-markets, which are estimated to make up less than 10% of group earnings exposure from FY17. The stock is screening as good value to the broker, despite forecasts being struck off trough fertiliser price assumptions in FY17.

FNArena's database shows six Buy ratings, one Hold (Morgans) and one Sell (Morgan Stanley). The consensus target is $3.69, suggesting 14.7% upside to the last share price. Targets range from $2.71 (Morgan Stanley) to $4.80 (Deutsche Bank).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms