Incitec Pivot Outlook Hinges On Key Prices

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Prices for Incitec Pivot's key fertiliser products are subdued and brokers are unsure when the market will signal a nadir has been reached.

-Promised capital management likely pushed out to FY18
-Decline in softs inventories, higher prices required as signal for fertiliser prices
-Cash-flow outlook suggests moderation in gearing metrics
 

By Eva Brocklehurst

Earnings weakness is expected to persist for Incitec Pivot ((IPL)) as prices of its key products for fertilisers are subdued and its explosives business remains tough. The question for brokers is when the market will signal prices have reached a bottom.

Morgans suspects the challenging conditions may even worsen in FY17. Materially higher interest expenses are also expected to affect profit growth. The broker observes the company's commentary at its earnings release was notably downbeat. Structural changes in the US coal market and a cyclical oversupply of ammonium nitrate in Asia-Pacific and the Americas are expected to weigh in FY17.

Morgans upgrades FY17 earnings forecasts by 1.8% because of lower gas and higher urea price assumptions but net profit estimates are reduced by 9.1% because of the expected higher net interest. Given the tough operating environment the broker believes the capital management that was promised following the commissioning of the Louisiana ammonia plant (WALA) is likely to be pushed out to FY18.

earnings declined 26% in FY16. The fall was driven by a sharp decline in fertiliser commodity prices in the second half. Fertiliser earnings were down 63%, explosives down 6% while industrial chemicals were up 26%.

Deutsche Bank also expects the cyclical reduction in global fertiliser prices may continue into 2017. The broker believes the Louisiana plant will provide a step change in earnings over the next two years and the company will fulfill its promise to return capital upon attaining reliable production. The Australian explosives business, meanwhile, is likely to benefit from higher coal and iron ore prices. Moreover, North American coal trends are improving and inventory declining, the broker notes.

Morgan Stanley remains bearish, especially for the near-term. While investors may be hopeful of a cyclical recovery, the first half could test their resolve. At some point the company will benefit from better fertiliser markets but the broker does not believe that time is now. Earnings per share estimates are lowered by 14-18% for FY17-18. Without a definitive indication that earnings have hit a low Morgan Stanley considers the stock significantly overvalued.

The broker acknowledges recent improvements in urea prices may be a turning point but notes that DAP (di-ammonium phosphate), ammonia and soft commodity prices continue to show negative momentum.

Goldman Sachs concurs. A significant decline in soft commodity inventories and subsequent stronger pricing are required in order to become more positive on the company's fertiliser and ammonia business. The broker, not one of the eight monitored daily on the FNArena database, maintains a Neutral rating.

Overall, earnings were in line with UBS estimates, although net profit was 3% ahead because of lower net interest. The company's manufacturing performance stood out, with production above nameplate capacity across Moranbah, Cheyenne, and Phosphate Hill. Adjusted net debt was also lower than the broker estimated, at $1.4bn.

UBS reduces forecasts for earnings per share by 7% which reflects lower average fertiliser price assumptions and a higher Australian dollar, partly offset by the realisation of $65m in additional cost reduction initiatives. The broker upgrades to Buy from Neutral, believing fertiliser commodity prices are bottoming. Also, the cash-flow outlook, even at spot prices, suggests a moderation of gearing metrics.

Macquarie agrees the explosives business is holding up well despite the challenging markets, while Moranbah hit record production of ammonium nitrate, yet also observes the company's language is softer regarding the near-term prospects for capital management, suggesting the timing is heavily dependent on the fertiliser price and the Louisiana plant running reliably.

Substantially lower capital expenditure after the completion of the plant should mean the gearing ratio falls to 1.8 in FY17 and capital management is more likely in FY18, in the broker's view.

Relative to its global peers, Macquarie notes that Incitec Pivot has the benefits of no potash exposure and a weaker Australian dollar. It also has a company-specific earnings driver in the form of the Louisiana plant, which could allow a significant step up in the free cash flow profile.

Ammonia prices have traditionally traded as a substantial premium to urea in the last 15 years but the broker notes the gap has closed in recent months and the two are now almost a parity. Macquarie does not believe parity will be sustained based on historical relationships.

Confidence with respect to phosphate pricing is critical to Credit Suisse's viewpoint. While there is some optimism in relation to improving coal production in Australia, Moranbah is at full capacity and, beyond some de-bottlenecking of the plant, company benefits little from any upside.

The broker expects the company to be the beneficiary of improving urea prices, where there appears to be some stabilisation in recent months. Credit Suisse asserts ammonia prices are also close to bottoming but believes it would be premature to call for a floor in phosphate prices at present, given large capacity increments are expected in 2017.

The results exceeded Ord Minnett's expectations, primarily because of a higher level of benefit from the business improvement program. The broker observes the company acted swiftly to make deeper and more widespread cuts to its cost base in the wake of persistently deteriorating macro conditions. Ord Minnett raises EBITDA and net profit estimates by an average of 8.5% and 3.6% respectively for FY17-19.

There are four Buy ratings, three Hold and one Sell (Morgan Stanley) on FNArena's database. The consensus target is $3.26, suggesting 4.8% upside to the last share price. Targets range from $2.36 (Morgan Stanley) to $3.95 (Deutsche Bank).
 

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