Incitec Pivot Cleans The Slate For FY19

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After being plagued by manufacturing issues in FY18 Incitec Pivot has a clean slate, with upside from higher fertiliser prices likely, although oversupply of AN will pressure explosives.

-Moranbah on track for production targets, contract re-negotiations
-Phosphate Hill has largest potential for upside
-Uncertainty continues for Gibson Island
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) has set aside the manufacturing issues that plagued FY18 and provided an upbeat outlook for the new reporting year. Despite the challenges, earnings growth was supported by a full year for the WALA (Louisiana) facility and a higher realised diammonium phosphate price at Phosphate Hill, as well as solid growth from Dyno Nobel America explosives. Net profit of $347m was up 9% and operating earnings (EBIT) of $557m up 11%.

However, manufacturing problems at three plants and unfavourable weather, as well as other one-off costs, meant the company did not benefit from the earnings leverage that it typically enjoys from materially higher fertiliser prices. Morgans believes the stock is fairly valued although recognises that strong fertiliser prices and a falling Australian dollar as well as the share buyback are supporting the share price.

Citi agrees the stock is in "fair value" territory, with management committed to buying back the remaining $90m of its buyback program, beyond which the company is signalling a preference to reduce debt amid organic growth initiatives.

With few M&A opportunities readily visible, Citi believes the stock lacks re-rating catalysts outside of a stronger-than-expected cycle. Deutsche Bank, in marking to market spot fertiliser prices and FX, is more confident there is 20% upside to earnings and retains a Buy rating.

The share price has had a good run and the margin of error in forecasting FY19 is even higher than usual because of the imminent re-pricing of the Moranbah foundation contracts, CLSA contends. The broker, not one of the eight monitored daily on the FNArena database, has an Underperform rating with a target of $4.00.

No specific earnings guidance was provided for FY19, although the company expects moderate earnings growth in Dyno Nobel Americas, with Asia Pacific volumes broadly in line, and warns that domestic ammonium nitrate oversupply will keep pricing and margins under pressure.

Macquarie believes the Phosphate Hill plant has the largest potential upside in FY19, given its significant operating leverage. Fertiliser prices are also a watching brief for Morgan Stanley, amid higher spot prices. Still, the share price reaction since May's lows, having rallied 17%, means it sits within the broker's average valuation and an Equal-weight rating is maintained.

Explosives

Explosives volumes grew strongly, particularly in the quarry & construction sector where Dyno benefits much more than competitor Orica ((ORI)). Macquarie suspects Incitec Pivot is less confident than Orica on Australian ammonium nitrate pricing, attributed to its experience in Western Australia and the impending renegotiation of Moranbah contracts.

The company is considering the potential expansion of Moranbah in 2021, as the market returns to balance, and will update the market in May next year. Macquarie assumes the issue is price and, on that basis, ammonium nitrate prices are headed in the right direction.

Import threats have receded with recent anti-dumping action. However, Credit Suisse suggests a recent spike in Henry Hub gas costs versus spot ammonia pricing will need to be watched. While the anti-dumping duty should help raise import parity prices, management has indicated that competitive strain between domestic operators will be the factor that determines the price trajectory over the next year or so.

Morgans points out earnings will decline in FY20 as the WALA plant will shut for maintenance, which will reduce volumes, while Dyno Asia-Pacific and Moranbah will also be affected by lost or re-priced contracts. The broker believes restoring fertiliser earnings may eventually lead to a corporate transaction, as the explosives and less cyclical businesses appear to be the company's preference.

Fertilisers

Morgans suggests, if the company can fix its reliability issues, it should be able to take advantage of higher fertiliser prices and a lower Australian dollar. Turning around Phosphate Hill, St Helens and Cheyenne in FY18 should mean the company can recover $34m in costs plus a cost reduction of $25m from a new gas contract at Phosphate Hill.

Credit Suisse believes these improvements effectively offset an additional $50m in gas costs at Gibson Island and the impact of WA contract losses. Uncertainty at Gibson Island continues, Macquarie notes, as short-term gas arrangements expire in December 2019. If the company is unable to source economically viable gas the plant will close.

The impact of the drought in eastern Australia now factored in, Credit Suisse believes, although whether a recovery occurs in FY19 is another issue. The broker acknowledges it was caught out in its calculations regarding the extent of the drought impact, which reduced operating earnings by -$20m.

Credit Suisse encourages investors to focus on the fundamentals of expanding cotton production, and high-value fertiliser use, also noting that the company's position in that regard is dependent on continued production at Gibson Island.

FNArena's database shows four Buy ratings and three Hold. The consensus target is $4.25, suggesting 4.7% upside to the last share price. Targets range from $3.95 (Morgans) to $4.60 (Deutsche Bank).

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