Australia | Nov 04 2019
Brokers remain comfortable with the FY20 outlook provided by Orica but suspect the share price already reflects an earnings recovery.
-Recent breakthrough in WebGen usage in large open-pit mines
-Ammonium nitrate market now emerging from a period of oversupply
-Uncertainty on costs and/or shortfall in obligations endangers FY20 outlook
By Eva Brocklehurst
Orica ((ORI)) has provided a positive outlook, with the main focus for the next six months being the re-commissioning of the Burrup plant in Western Australia. Management has guided to higher earnings in FY20, supported by the take-up of its technology and increased demand for its products.
The company has also rewarded shareholders by providing reasonable growth over FY19, in the context of a challenging broader market. Brokers are comfortable with the outlook but suspect the share price already reflects an earnings recovery.
FY20 volume growth of around 5% is expected, supported by new contracts in Europe and Canada as well as good growth in the Asia-Pacific region. The company believes a higher gold price will support volume growth for explosives and cyanide.
A renewed focus on customer engagement is also expected to improve penetration of the company's products and technology. Morgans assesses the company should benefit not only from volume growth and a better manufacturing performance but, potentially, price rises.
Citi notes the company's wireless technology recently made a significant breakthrough, which could pave the way for usage in large open-pit mines and provide a significant earnings contribution. The WebGen technology has passed muster in underground mines but now the trial with BHP Group's ((BHP)) Poitrel open cut mine in Queensland has been successfully completed.
However, Ord Minnett remains cautious about the outlook, given some recent checking of channels indicated a -30% discount on electronic blasting system (EBS) contract pricing in a developing market, supporting suspicions of potential volume-for-value trading, affecting margins.
The broker expects ammonium nitrate volumes will increase 4.2% in FY20, amid strong demand globally. UBS assesses global ammonium nitrate markets are emerging from a period of oversupply and the recovery in demand will be underpinned by a normalisation of mine activity.
Firming dynamics in the market will drive more favourable contract re-pricing into FY22 and, as Macquarie points out, ammonium nitrate leverage will be in focus as the contract book is substantially locked in until then.
The broker notes there was no reference to the outlook for ammonium nitrate pricing vs the "firm" pricing forecasts in the first half result in May. Hence, prices are expected to be broadly flat in FY20. Earnings growth is expected but with a skew to the second half that is greater than normal because of the ongoing losses from Burrup in the first half.
In FY19, volume increases in the Americas, improved earnings for Minova and a full year contribution from GroundProbe were offset by weaker pricing and increased sourcing costs to Pilbara customers, as well as temporary disruption to the Newmont gold mine in Mexico. As FY19 was less disrupted, Credit Suisse assumes the company is getting on top of its manufacturing problems.
Orica delivered a positive update on its Burrup project, noting rectification works are running to schedule. Cash flow will be affected by an increase in inventory because of the rectification works and a build up in safety stocks in advance of the SAP system going live. Nameplate capacity is expected to be achieved through the second half of FY20 and Macquarie forecasts 40% utilisation over FY20.
Burrup is an even larger swing factor in FY20 now, Credit Suisse assesses, as the company requires additional volume to fulfill the BHP contract. The timing of the re-start is important, as the cost of any delays increases with the additional volume resulting from the commencement of the BHP contract in early 2020.
Ord Minnett agrees that uncertainty regarding costs and the sourcing of any shortfall to obligations endangers the FY20 earnings outlook, irrespective of strong industry trends elsewhere.
While Burrup appears more promising by the day, the broker is not expecting a stabilisation in the near term and remains cautious about the commissioning timeline. Orica is likely to source from Yarwun and a third party while freight will be a key consideration for additional contract tonnage.
The broker forecasts Burrup production of 135,000t in the second half and utilisation of around 45% in FY20 moving to 88% in FY21. Ord Minnett considers the less-than-certain outlook for Burrup as well as headwinds in Mexico are reasons why the premium in the stock vs its rival Incitec Pivot ((IPL)) is unwarranted.
FNArena's database has six Hold ratings and one Sell (Ord Minnett). The consensus target is $21.91, suggesting -7.8% downside to the last share price. Targets range from $17.00 (Ord Minnett) to $24.50 (Citi).
See also, Orica's Technology Advantage Key To Upside on July 31, 2019.
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