Orica’s Technology Advantage Key To Upside

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Orica believes its technological breakthrough should offer a competitive advantage and contribute to earnings growth in FY21. Yet brokers assess the positive outlook is already factored into the shares.

-Potential to break five-year earnings range in FY20
-Lingering uncertainty around near-term profit profile of Burrup
-Margin assumptions lift but will this be foiled by higher gas prices?
 

By Eva Brocklehurst

Explosives markets are moving positively for Orica ((ORI)), in step with the company's technological advancements that provide a major breakthrough in safety and efficiency in complex mining situations. Management believes its electronic blasting system (EBS), WebGen 100 and BlastIQ, offer a competitive advantage and should contribute to earnings growth in FY21, and more meaningfully in FY22.

The BlastIQ digital blasting data platform has now been adopted by 25 customers across 35 mining sites, improving mine productivity by 5% and reducing drill costs by -10%. For WebGen 100 customers, a 34% ore recovery and 20% productivity improvement has been reported.

Morgan Stanley is now more confident the company may break its five-year earnings (EBIT) range of $600-700m in FY20. That said, the current share price approximates fair value and the broker would need to witness further upside to earnings before adopting a more positive stance. Citi also points out the company has conceded that while confident of solid earnings growth, capital expenditure should stay high at around $350m per annum, for the next few years.

Management has indicated incremental upside in Latin America, Minova products and GroundProbe. GroundProbe is increasingly adopted to prevent failures in tailings dams, with an ability to target blasting more precisely. Morgan Stanley assesses the improved earnings outlook in these areas is somewhat offset by higher assumption for the AUD/USD.

While management has indicated the performance of the business has stabilised, partially because miners have returned to more normal mine plans, Ord Minnett envisages risk with respect to clear growth drivers in the years ahead, for both EBS and electronic delay detonator (EDD) sales.

Credit Suisse considers the hesitancy of management in specifically forecasting upside is natural. The broker has been critical in the past of the way in which the company has managed its manufacturing base. However, this now appears more in tune with the fundamental improvements.

Technology

Yet, an incomplete business proposition was presented for the size and adoption rates for the WebGen EBS, as well as where the drivers of growth in technology will come from, Ord Minnett asserts.

WebGen 100 and Bulkmaster 7 have been the key advances in the technology of blasting but, in the broker's view, the 220 blasts that have been fired globally are not conclusive. Hence, Ord Minnett reserves judgment regarding the feasibility of the technology outside ring blasting and underground metal mines and assesses the bull case relies on the mass adoption of a more expensive product, and competition is likely to cause price deflation.

Credit Suisse is also a little cautious about technology stories in mature industries but believes Orica has demonstrated increasing customer take-up. If the company is correct, the broker expects the industry to move to a higher technology base and raise barriers to entry, which will drive consolidation and improving returns.

While acknowledging the merits of the technological proposal, Morgan Stanley observes history has revealed that monetising and maintaining the benefits of being a key differentiator can be difficult. Still, Macquarie points out the building up and adoption of technology is a slow process, even though it may erode the company's first-mover advantage in coming years.

Burrup/Yarwun

Ord Minnett assesses the primary driver of weaker profits in FY20 is Yarwun amid the shifting of volumes to account for any shortfall at Burrup, which will result in higher freight costs. There is also lingering uncertainty around the near-term profit profile of Burrup.

Burrup has produced around 40,000t of ammonium nitrate and 12% utilisation is expected over FY19. Management was positive about the prospects of Burrup going live in the second half of FY20 and has guided to FY21 production of around 290,000t. Macquarie agrees the performance of Burrup post the current rectification work needs to be assessed. New equipment is being installed over the next 6-9 months, with March the key month for start-up.

UBS concludes, as the market recovers from the commodities downturn and mine production normalises, there will be an increase in explosives demand, but while the company has late-stage leverage to the mining recovery and the market dynamics are firming this is largely factored into the stock.

Credit Suisse is also more confident about tightening supply and robust demand as well as product mix leading to a lift in margin assumptions through FY22-25. Supply is tight on the east coast, with imports to Australia running at 200,000t in 2019 versus 100,000t in 2018. This creates scope for Yarwun to fill capacity, in the broker's view, once Burrup is operational and Yarwun's commitments to west coast supply cease.

Macquarie notes contract renewals will not occur in the Asia-Pacific book until FY22 so price improvements are unlikely until then. Contracts for gas supply are now under discussion and the company has highlighted the risk of Kooragang Island and Yarwun gas increasing again in three years time.

FNArena's database shows six Hold ratings and one Sell (Ord Minnett). The consensus target is $20.29, signalling -6.8% downside to the last share price. Targets range from $16.20 (Ord Minnett) to $21.50 (Citi).

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