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Incitec Pivot Could Stall In FY18

Australia | Nov 16 2017

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

Incitec Pivot has started FY18 from a strong position, as fertiliser prices have improved, the Australian dollar is weaker and the outlook for the US explosives market is buoyant. But brokers are not convinced.

-Strong cash flow the main positive, $300m buyback announced
-Gibson Island facing potential closure in 2018/19
-Upside to spot fertiliser prices seen largely factored into share price

 

By Eva Brocklehurst

FY17 results for Incitec Pivot ((IPL)) were characterised by improved operating rates and market conditions. Volume growth in the Americas explosives division was strong, up 11%, and broadly based across quarry & construction as well as in metals and coal. Q&C accounted for 35% of the Americas explosives revenue in FY17.

A recovery in coal and metals was evident in Asia Pacific. The company cited a -$26m impact from lost production because of the turnaround at Moranbah as well as weather-related events. Asia Pacific fertiliser results included a $19.8m gain on asset sales.

Morgans notes FY18 guidance was not specific but management's outlook is cautiously optimistic and the stock appears fairly valued in the absence of a further appreciation of fertiliser prices.

Strong cash flow was the main positive for brokers, along with reduced capital expenditure requirements as the WALA plant in Louisiana is now up and running well. Hence, the company has announced the much-anticipated $300m share buyback, generally estimated to be around 5% accretive.

Morgans forecasts net profit in FY19 to be relatively flat, assuming Gibson Island is closed because of uneconomical gas prices and US ammonia earnings slide because of a plant shutdown.

Gibson Island plant faces potential closure in 2018/19 but this is a well-known risk in Macquarie's view, although it remains the major strategic/financial issue facing the new CEO over the next 6 to 9 months. The broker finds some heat coming out of the global urea markets after the Indian tender was cancelled but ammonia still appears cheap versus urea at current prices.

CLSA suggests that while FY17 results produced an increase in operating earnings of 17%, this includes items such as volume growth in US explosives and a $20m gas saving at Phosphate Hill, which are variable elements that may be greater than first appear. CLSA expects production of ammonia in Russia to start ramping up and stem a price recovery.

On the other hand, Deutsche Bank believes the company is well-positioned to benefit from improving demand for explosives in North America and Australia as well as from the recent increase in global fertiliser prices and depreciation of the Australian dollar.

Productivity offset the difficult fertiliser market conditions and the buyback should provide some support for the share price. That said, Credit Suisse considers the stock expensive in a market for fertiliser that is likely to weaken in FY18. The broker expects fertiliser prices to weaken throughout 2018 before supply begins to tighten thereafter.

Credit Suisse downgrades to Underperform from Neutral, following the rally in the share price. The broker asserts that the natural inclination of an incoming CEO to reset any deficiencies in the cost base means some conservatism might be warranted in near-term forecasts.

Credit Suisse found it interesting that the company did not call out US domestic steel production as a significant input for FY18, despite the continued recovery expected in that sector.

Buyback

CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has an Underperform rating and $3.80 target. The broker remains sceptical about the benefits to shareholders of the buyback, estimating accretion is less than 1%, although being small is unlikely to compromise any growth strategies that may be formulated over the next six months.

The strategic direction under a new CEO remains to be seen and, while the buyback will provide technical support, the broker believes exposure to volatile commodities with a high forecasting margin for error has not changed. The risk is that these do not support an upgrade cycle.

The capital management initiative arrived earlier than Citi expected. As near-term markets remain tight and WALA ramps up to full capacity, spot prices imply further upside risks to FY18 estimates. That said, the broker believes much of the price recovery is already priced in.

Morgan Stanley also suspects the earnings trajectory is likely to disappoint. Earnings from explosives have failed to pace volume growth so far and there is little evidence to the broker of underlying leverage in operations. While the company should benefit from the recent rally in fertiliser prices, Morgan Stanley envisages downside risk to spot prices over the near-term. The broker, therefore, struggles to find valuation support above current levels.

FNArena's database shows three Buy ratings, three Hold and one Sell (Credit Suisse). The consensus target is $3.91, signalling -0.5% downside to the last share price. Targets range from $3.49 to $4.22.
 

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