Outlook Deteriorates For Incitec Pivot

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

-Are earnings expectations too high?
-Potential for disappointment
-Capital management still expected

By Eva Brocklehurst

Incitec Pivot ((IPL)) is about to start up its long-awaited Louisiana plant but the market is not providing the best outlook, brokers maintain. The company will commission the 800,000t per annum ammonia project in the September quarter and the plant is expected to operate at an average loaded rate of 80% through FY17.

Credit Suisse adopts new fertiliser price assumptions, which result in downgrades to ammonia, urea and di-ammonium phosphate (DAP) prices across the forecast horizon. The ammonia and phosphate markets appear to the broker to be supply driven and capacity additions are larger than the demand growth outlook through 2016-18.

The broker expects Incitec Pivot may experience particularly adverse price outcomes for DAP in its traditional export markets of Bangladesh, Vietnam and Thailand if Chinese producers seek to maintain export market share in 2016 and 2017.

Credit Suisse hears the valuation argument based on long-term fertiliser prices but believes the deteriorating near-term outlook (to FY18) warrants a downgrade to Neutral from Outperform, with a target of $3.10.

On the positive side, the company's balance sheet is de-leveraging and cash flow is improving and the broker's base case calls for a reduction in the company's capital base in FY17 and FY18. Given the improving cash flow and cyclical nature of earnings downgrades, Credit Suisse expects the stock will gravitate towards a yield of 5%, which lends support to its valuation and target.

UBS also incorporates the potential for up to $200m in a buy-back in its analysis, expected to be announced at the FY16 results in November. Yet the broker believes the market may be disappointed. Consensus expectations suggest up to 10% or a $500m buy-back but this, UBS maintains, would imply a significant lift in fertiliser prices, which is considered unlikely.

The broker expects the completion of the Louisiana project will mean cash flow improves significantly and there will be some uplift from FY16, but the global ammonia market is headed for a period over oversupply in the next several years as new capacity comes on stream in the US. Any earnings benefit is also expected to be offset by a decline in the existing business, with earnings constrained throughout FY17-19.

Earnings growth estimates appear too aggressive, and UBS cuts its FY16 earnings estimates by around 5% and FY17-20 by 20%, driven by a cautious outlook for ammonia prices. Forecasts for DAP and urea pricing are also cut to reflect current cost curve estimates. All three commodities face additional low-cost supply coming into the market over the next 2-3 years in a challenging demand environment, the broker maintains.

Furthermore, surpluses of corn and wheat, following bumper crops in recent years, are also likely to constrain any meaningful uplift in these soft commodities in the near term. UBS suggests the market is not positioned for further earnings disappointment from the fertiliser business, noting the stock has underperformed the Australian market by 25% in the year to date.

Added to this scenario is the prospect that capital management disappoints and results in consensus downgrades. UBS, too, finds little scope for outperfomance and downgrades its rating to Neutral from Buy, with a $3.10 target.

The company has signalled that new large scale growth projects will be unlikely to be pursued in the near term. Completion of Louisiana will result in a reduction in capital expenditure to $255m in FY17 from $470m in FY16. This will be partially offset by shutdown-related spending at Moranbah.

UBS expects net capex in the order of $200-250m will be maintained over the near term. Longer term, the broker likes the Louisiana asset and envisages the US market will remain a net importer of ammonia with global-linked pricing expected to underpin returns over 15%.

Morgans acknowledges weakening fertiliser prices and a rising Australian dollar and concludes the fall in the ammonia price and strength of the gas price will reduce the returns from Louisiana.

Meanwhile, the US coal production outlook is weak and operating conditions in the Asia Pacific explosives business are challenging, with the broker citing adverse product mix, customer in-sourcing and margin pressure.

If fertiliser prices remain weak then this broker also believes consensus forecasts are too high, downgrading FY16 and FY17 estimates by 2.6% and 15.9% respectively. Despite the downgrade, Morgans still expects strong earnings growth in FY17, reflecting the Louisana project operating at 80% and a lower Australian dollar, as well as lower cash costs at Phosphate Hill and a lack of gas issues at Moranbah, retaining a Hold rating and $3.05 target.

FNArena's database has four Buy ratings, three Hold and one Sell (Morgan Stanley). The consensus target is $3.50, suggesting 21.1% upside to the last share price. Targets range from $2.71 (Morgan Stanley) to $4.80 (Deutsche Bank).
 

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