Incitec Pivot Paves The Way To FY20 Recovery

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Incitec Pivot has provided sharply lower earnings guidance for FY19 after a first half plagued by outages and manufacturing problems.

-New global manufacturing strategy expected to deliver ammonia upside by FY22
-Explosives volumes dependent on normalising of mining demand
-Some improvement in fertiliser demand envisaged
 

By Eva Brocklehurst

A swag of events and manufacturing setbacks hampered Incitec Pivot ((IPL)) in the first half, which more than countered higher fertiliser prices and a weaker Australian dollar.

Underlying net profit dropped -72% and underlying earnings (EBIT) were down -15%. The non-recurring events included The Mt Isa rail line outage, disruptions to gas supply and manufacturing problems at a number of plants, overlaid by drought conditions on the east coast of Australia that affected the contribution from fertilisers.

The company has provided formal earnings guidance for FY19 for the first time, expecting earnings (EBIT) of $370-450m, down -25-34% and materially below previous broker forecasts. This guidance is subject to more normal seasonal conditions and no further manufacturing outages. The company also assumes some improvement in fertiliser prices.

The interim results were better than Deutsche Bank expected, yet while company is working through the challenges there are few tangible positives envisaged on the immediate horizon, apart from a rising urea price, recent rainfall, and a lower Australian dollar.

Morgan Stanley finds it difficult to envisage much growth, as the company will face a headwind of around -$22m in FY20 from contract losses and price re-setting. At this point, the broker also anticipates headwinds from fertiliser prices.

Manufacturing Strategy

A new global manufacturing strategy was announced, expected to progressively deliver $40-50m per annum of earnings upside across the ammonia portfolio by FY22. The company is targeting reliability of 95% by the end of FY21, which Macquarie compares with a baseline average of 85%. The broker notes the company's target is to be achieved via a new manufacturing team, greater use of predictive maintenance and a focus on safe and reliable operations.

UBS highlights the importance of the company executing on this strategy and envisages a positive outlook for explosives volumes, as mining demand normalises, although market dynamics and re-pricing will weigh on growth and operating leverage. At this point, UBS expects conditions in Australian farming, hence fertiliser demand, will normalise.

Credit Suisse welcomes the focus on improving profit from plant reliability and low-capital, technology-related investment in the ammonium nitrate business. The company maintains a solid balance sheet and the broker expects de-gearing to continue, as sustaining capital expenditure is well below the cash being generated.

The broker accepts that significant underlying growth in earnings is largely absent, but remains of the view that management can, potentially, distribute more cash to shareholders over the medium term.

Gibson Island

Morgans expects a strong earnings rebound in FY20 as the stronger outlook for Dyno North America and a normalisation of manufacturing come into play. The main overhang is the future of Gibson Island. The company is continuing to have discussions regarding the gas supply and operations at the site will cease in December if affordable gas cannot be secured. The latest estimate for closure costs is $65-75m.

Citi believes the likelihood of achieving lower gas prices is limited. Closure costs are expected to be partly offset by the sale of landholdings, at around $30m, and the company is now looking to use part of the site to import ammonia from an existing storage tank.

Second Half

Morgans points out the company's earnings are seasonally skewed to the second half, which benefits from fertiliser application for winter cereal crops in April/May/June and for cotton in August/September. North American explosives earnings are also skewed to the second half, given the bias to higher-margin quarry & construction markets in the northern summer.

Nevertheless, second half earnings will still be affected by the Queensland rail outage and the closure of the Portland manufacturing facility. There is also the potential for lower diammonium phosphate, urea and ammonia prices. Positives include a slightly lower Australian dollar and a drop in the Henry Hub gas price because of warmer than normal temperatures in the US.

Macquarie assesses the downgrade cycle is close to the bottom and FY19 is likely to be the seasonal/cyclical low point, as internal drivers are improving. The Waggaman plant in Louisiana has been running consistently since April and the Queensland rail line is now functioning.

The broker notes there are -$209m in pre-tax non-recurring items in FY19 and this provides a sense of underlying earnings improvement in FY20. The earnings impact from non-recurring events totalled -$141m in the first half, comprising the Queensland rail outage, third-party gas disruptions, and manufacturing issues at Waggaman & Phosphate Hill. The only updated estimate, Macquarie observes, was an increase in the second half Queensland rail outage impact, to -$55m from -$40m.

Credit Suisse points out second half guidance makes no significant allowance for disruptions. Forecasts for fertiliser and gas prices have a $10m positive impact on the broker's earnings forecasts for FY19 versus the company's price estimates. The market is expected to welcome the re-basing of ammonium nitrate contracts at Moranbah and there is scope for price upside as the east coast ammonium nitrate market tightens over the medium term.

Morgan Stanley acknowledges underlying growth in North American explosives volumes and assumes some improvement in Australian seasonal conditions, yet considers a clear end to the downgrade cycle is a prerequisite for any sustained outperformance, and this will require an inflection point in the fertiliser price and/or greater confidence in manufacturing performance.

FNArena's database shows four Buy ratings and four Hold. The consensus target is $3.65, signalling 13.3% upside to the last share price.

See also, Incitec Pivot Issues Brushed Aside on April 3, 2019.

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