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Incitec Pivot Re-Rating Dependent On Waggaman

Australia | May 19 2021

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

Having resigned FY21 to being a year of transition, brokers want to see several periods of stable operations at the new WALA plant before contemplating a re-rating for Incitec Pivot.

-Incitec Pivot management reiterated expectation of strong earnings growth in second half FY21
-Waggaman plant needs resolving before the stock can materially re-rate
-Coal exposure remains an overhang in medium term on explosives volumes

By Mark Story

Given the three plant maintenance turnarounds and a number of outages, Incitec Pivot’s ((IPL)) weak first half FY21 earnings (EBIT) result of $110m, a large (-20%-plus) miss versus consensus expectations – and down -30.8% on the previous period – came as no surprise to the market. The first half result included the -$59m impact from planned turnarounds and a -$14m hit from unplanned outages.

Due to a -13% reduction in Dyno Nobel Americas revenue to $671.1m and a -7% decline in Dyno Nobel APAC revenue to $455.8m in the six months to 31 March, the company reported a -6.7% decline in revenue to $1724.1m. However, this was partly offset by a 2% lift in Fertilisers Asia-Pacific revenue to $628.3m.

But with strong earnings growth more skewed than normal to the second half – due to first half plant issues and timing of recent fertiliser price increases – brokers seem willing to relegate the half-yearly result to a cyclical low for Incitec Pivot from both a volume as well as a pricing perspective.

Incitec Pivot declined to provide firm guidance, but management reiterated its expectation of strong earnings growth in the second half reflecting materially higher fertiliser prices, favourable seasonal conditions and strong explosives volumes in North America.

Regarding the Dyno business, Incitec Pivot continues to target technology driven earnings growth of 10% between FY20 and FY22.

Management also expects unsold manufactured ammonium phosphate product on hand to realise in excess of $25m in profit in the second half at current market prices. Management guided to one planned plant turnaround in the second half compared with three completed in the period.

Waggaman: The Problem child

While brokers are comfortable the broader business is in good shape, they’re under no illusions the problem child for the company, WALA the new ammonia plant at Waggaman, Louisiana, needs to be addressed. While Morgans maintains an Add rating, with $2.92 price target, given the company’s leverage to attractive industry fundamentals, the broker recognises the issues at the Waggaman plant need to be resolved before the stock will materially re-rate.

Previously disclosed repairs at the Waggaman plant are expected to take up to the end of May, followed by a plant re-start through June/July. It’s understood a reliability taskforce will then address longer-term reliability issues to year end 2021 with a “stretch” objective to return the plant to reliable nameplate production for FY22.

Meantime, the company’s current plan is to replace the faulty heat exchanger and tie in a new boiler at the end of calendar year 2022.

Management expects -$9m in fixed cash costs in 2H21 to complete plant repairs, plus -$6m in trading losses from sourcing ammonia over the April/May plant outages. The company is also on target to deliver incremental cost savings of $60m per annum by FY22.

Near-term downgrades

Based on Morgans’ estimates the outages and four turnarounds have reduced FY21 earnings by over -$178m. Unsurprisingly, due to the latest Waggaman plant issues and more conservative assumptions on this plant going forward, the broker has downgraded FY21, FY22, and FY23 net profit forecasts by -15.4%, -4.8%, and -7.6% respectively.

But from here, Morgans suspects FY21 earnings will depend on Waggaman’s production, fertiliser prices (likely to fall from current levels) and the next cotton season with high margin Big N sales falling in either the fourth quarter of FY21 or first half of FY22. The broker forecasts strong growth in FY22 from reduced shutdowns/increased production volumes, a recovery in Asia Pacific explosives demand, strong fertiliser prices, a better cotton season on top of the full benefits from the company’s cost out program.

Despite the weaker result, JP Morgan’s view on Incitec Pivot remains unchanged, with an Overweight rating and target price of $3.00. The broker believes there’s potential upside to earnings if fertiliser prices remain elevated, and management can hit its Manufacturing Excellence target of -$40-$50m by full year FY23.

What could pivot a turning point in sentiment towards the stock, adds the broker, is the business update in August, assuming the Waggaman plant is running reliably through to that point. Given that significant resources have been allocated to re-start and improve reliability going forward, JP Morgan factors in 19.5 weeks of production in 2H21 (including 2 weeks in April).

Future outlook

JP Morgan expects significant earnings growth in 2H21, driven by the Fertilisers division. The majority of the uplift relates to Phosphate Hill which is benefitting from much improved DAP prices, with Gibson Island and Distribution also expected to improve earnings.

However, due the delayed timing of manufacturing excellence benefits, lower margins in DNA, and share count updated for previous model error, the broker’s earnings per share (EPS) forecasts for FY21 and FY22 drop by -11.8 and -13.9% respectively, with earnings (EBIT) declines of -1.6% in FY21 and -3.7% in FY22.

Macquarie has also reduced FY21 and FY22 EPS forecasts, albeit by considerably less than JP Morgan at -2% and -1% respectively. However, the broker expects Dyno Americas to show strong growth on a covid affected comp (2H EBIT up 22%) with second half growth expected in all three end markets – notably quarry and construction (Q&C) and precious metals.

The broker’s headline 1H:2H earnings skew is 24:76, which is 30:70 if normalised for $25m profit in stock reversal. However, this assumes no further material plant issues in the second half which has proven problematic.

Macquarie is forecasting 80% average utilisation for the plant in the final four months of the year.

The broker maintains an Outperform rating on the stock, with the price target reducing to $2.91 from $2.96. While marking to market for fertiliser prices remains in positive territory, Macquarie reminds investors reliable and consistent Waggaman plant production is key in order for Incitec Pivot to leverage what remains an attractive fertiliser and explosives cyclical/seasonal recovery.

Higher returns over the medium-term

With Incitec Pivot’s focus on improving manufacturing reliability, reducing costs and capital discipline are setting the stage for higher returns over the medium to longer term, hence Citi rates the company a Buy, with a target price of $2.90.

Citi believes the coal exposure remains an overhang in the medium term on explosives volumes, with the focus on accelerating technology trials and retaining long term explosives supply contracts.

Given that current fertiliser prices are trending strongly, the broker expects the company to benefit from improving markets for nitrogen and phosphate fertilisers, whilst improving margins from leveraging its Delta E technology.

Citi’s modest earnings forecast changes over FY21-22 include increases by 2% over FY21-22 while the broker has slightly trimmed FY23 earnings (-2%).

Citi expects explosives volumes in FY21 to be flat as base and precious metals offset lower coal volumes and flat Q&C volumes. Overall, Citi’s FY21 earnings changes are driven by better than expected Waggaman earnings amid the plant disruption.

Citi has raised ammonia price assumptions for FY21-FY23 by 22%-53% following strong year to date prices, resulting in a significant uplift in the broker’s segment earnings estimates.

Citi has lowered sales and earnings for the DNAP segment on the back of the ongoing China ban on Australian coal and loss of a medium sized metals customer. The broker now expects 2H21 volumes to be -7% lower on the previous period, and FY21 ammonium nitrate volumes to be -11% lower.

For FY22, Citi expects volumes to grow at 2% on the previous period. Citi has lowered fertiliser earnings estimates largely driven by higher cost/tonne for the Phosphate hill plant and slightly lower distribution volumes.

The broker’s DAP price forecasts for FY21, FY22, and FY23 are US$463, US$495, and US$422/mt respectively. By comparison, the company’s realised DAP price for the reported period was US$426/tonne compared with US$286/tonne in the previous period.

Based on ongoing covid impacts with four turnarounds in one year, the broker is resigned to FY21 being a year of transition, with the near-term focus being earnings growth post the major turnarounds in FY21 and FY22.

Given the negative overhang of plant performance, Credit Suisse has a Neutral rating on the stock, and has reduced the target price to $2.51 from $2.83. While Incitec Pivot’s management contends that the Waggaman plant build quality is satisfactory, the broker believes the company needs to produce several periods of stable operation to prove its case.

FNArena's database has one Add, one Outperform, one Buy and one Neutral rating on Incitec Pivot. The consensus target is $2.90, suggesting a circa 20% upside to the current price.

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