Incitec Pivot Beholden To Commodity Prices

This story features INCITEC PIVOT LIMITED, and other companies. For more info SHARE ANALYSIS: IPL

Unplanned outages at the ammonia and phosphate plants have affected sentiment toward Incitec Pivot. Fertiliser and explosives prices are key going forward.

-Lower ammonia and phosphate production signalled for FY19
-More reliant on firmer commodity prices in FY19
-Is value emerging in the stock?
 

By Eva Brocklehurst

Outages have plagued Incitec Pivot ((IPL)) during January, leading to reductions to earnings (EBIT) estimates in FY19. The outages, at Waggaman in Louisiana and Phosphate Hill in Queensland, have a combined impact on FY19 earnings of -$45m.

As the investment story is centred on squeezing more from the existing asset base, Credit Suisse understands why the outages can have a large impact on investor sentiment.

Still, the broker highlights US dollar earnings remain attractive, given the potential for further Australian dollar weakness. Expansion of Moranbah remains the most significant use of capital, while the next news item is likely to be a decision on Gibson Island, which the broker suspects will be closed.

Macquarie believes this is just another reminder of the variability at play in the stock, and considers the issues are operational rather than systemic. The broker expects a seasonal rebound in global fertiliser prices in the first half of 2019, reflecting solid North American demand.

The outage at the Waggaman ammonia plant is expected to reduce production by -80,000t in FY19, taking annual production to around 90% of nameplate, and stems from problems with the carbon dioxide removal system. The plant has been out of operation for 2.5 weeks and the repair timeline suggests a return to normal by mid February. This is the first material issue with production in almost 2.5 years of operations.

Meanwhile, the Phosphate Hill fertiliser plant has resumed normal operations after an outage caused by leaks at the phosphoric acid facility in early January. FY19 production is likely to be reduced by around -50,000t. The company is currently renewing its Moranbah, Queensland, ammonium nitrate contracts.

The outages disappointed Morgans because they follow gas supply problems in December. The broker now expects FY19 profit will be marginally lower than FY18. Successive manufacturing issues over the last two months signal to the broker the growth target is unlikely to be met. Incitec Pivot will also be affected by lost explosive contracts from Roy Hill and BHP Group ((BHP)).

The decline in the share price has provided a good buying opportunity, in Deutsche Bank's view, as the outages are largely one-off in nature and extensive corrective action is being taken to ensure they do not reoccur. The broker points out the market is capitalising the unplanned outages and, while reducing FY19 earnings estimates by -7%, maintains FY20 forecasts.

UBS reduces FY19 estimates by -7% but retains FY20/21 forecasts, expecting manufacturing issues will be resolved. The broker foresees a positive outlook for explosives volumes, as mining demand normalises, but expects oversupply and re-pricing of contracts in the near term will weigh on growth. Similarly, recent drought in Australia may also weigh on demand for fertilisers.

Pricing Outlook

Morgans notes, since December, ammonia and urea prices have fallen while diammonium phosphate and the AUD/USD are largely stable. Partly offsetting lower commodity prices is a reduction in the US gas price. Still, internal issues are reducing leverage to more favourable fertiliser prices and a lower Australian dollar.

Morgans asserts that restoring fertiliser earnings may eventually lead to a corporate transaction, given explosives are a less cyclical business and appear to be the company's preference.

Citi agrees this is a setback to the company's strategy on manufacturing excellence. Lost volumes and higher gas costs at Gibson Island mean Incitec Pivot is now heavily reliant on firmer commodity prices in FY19. While value is emerging in the stock, the broker believes catalysts are lacking.

Macquarie factors in a -$10m impact on earnings over the next two years because of lower contracted ammonium nitrate prices, although does not assume any loss of volume. Morgan Stanley lowers fertiliser price assumptions. Since mid November urea prices decline by around -12% while the benchmark Tampa ammonia price has declined by -20%. Diammonium phosphate has been more resilient, down -4%.

The broker notes the stock has underperformed fertiliser prices since November and therefore, as there is some seasonal support over the next two months, this should underpin the share price. Nevertheless, Morgan Stanley is cautious, pending more clarity on the impact of re-negotiated explosives contracts.

Given the recurring manufacturing issues, the broker lowers ongoing capacity utilisation rates across its forecasts. Hence, any sustainable improvement in the performance represents upside to forecasts.

There are four Buy ratings and four Hold on FNArena's database. The consensus target is $3.94, suggesting 18.2% upside to the last share price.

See also, Incitec Pivot Cleans The Slate For FY19 on November 14, 2018.

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