Australia | Sep 25 2023
This story features ORICA LIMITED, and other companies. For more info SHARE ANALYSIS: ORI
Orica's Sustainability Investor Day included a positive trading update and laid out the company's green ambitions
-Trading update suggests double-digit earnings growth in FY23 and FY24
-Management raises emission reduction targets
-Scope 3 target introduced
-Installation of emissions abatement technology finalised, yielding strong results
-Management turns to hard-to-abate emissions
By Sarah Mills
Orica’s ((ORI)) widely anticipated Sustainability Investment Day was spiced up with a trading update.
Double-Digit Earnings Growth For FY23 And FY24
Orica reaffirmed September FY23 earnings guidance (September-end) and expects continued strength throught FY24 thanks to buoyant global and domestic markets. Management advised that so far September-half trading had not slowed as some might have expected heading into a global slowdown.
Both US and European activity have improved seasonally so far in the September half, and mining, blasting and ammonia business are all staging solid performances, advises the company.
Even the global slump in nitrogen prices barely impacted on the company’s ammonia business. UBS observes North and South American ammonia demand is benefitting from Russian supply disruption.
Brokers now expect the company’s return-on-natural-assets (RONA) targets will be raised given they are travelling at the upper end of management’s target range at 12.5%. The top of the target range is 13%.
Second half maintenance was completed on time and on budget.
On the downside, Citi observes capital expenditure is expected to be at the upper end of Orica’s $400m to $420m guidance, and observes the company is exiting Venezuela, incurring a -$20m post-tax bill, listed as a significant item.
The big negative was news of a two-month scheduled maintenance shutdown of Kooragang Island in the first half FY24, which Macquarie estimates will take -$30m from earnings in the half, and slog margins given the plant is high margin. Jarden would have appreciated better disclosure on the earnings (EBIT) impact of the Kooragang Island closure.
The broker had estimated a -$16m EBIT impact from Orica sourcing third-party ammonia at today’s prices but the broker hadn’t included the -$15m loss of its gas-to-ammonia conversion margin earned on tons out of Kooragang Island and is awaiting the FY23 result for further details.
Down To The Business Of The Day – Sustainability
While the trading update added spice, the sustainability announcement provided the meat.
Jarden believes thermal coal declines remain a key risk for the company given decarbonisation trends could affect its client base over the long term. The broker observes the Kooragang Island plant is now 54 years old and while fully depreciated on the books, needs to remain competitive as the company’s most vertically integrated asset.
The broker believes the Kooragang business needs to diversify its client base away from Hunter coal and expects the building of a larger 30k ammonia storage tank will pave the way for greater exporting.
ESG and Sustainability Impacts
Orica made several announcements that appear to have been well received by brokers.
Management raised emission reduction targets, announcing plans to cut net scope 1 & 2 emissions by at least -45% by 2030 from 2019, compared with -40% previously. The company also set a maiden interim target of -30% by FY26.
Increasing targets and setting of interim targets are high on Big Capital’s tick-list at the moment, and ESG investors are also favouring companies that set Scope 3 targets.
Orica did introduce a Scope 3 target for a -25% reduction by 2035. It’s quite a way out, but it’s a start. Assuming it is fairly conservative, it also gives investors some idea of global progress on decarbonisation as it relates to Orica’s business.
Equally important, Big Capital likes to see actual decarbonisation progress and Orica appears to have satisfied on this front after targeting its easy-to-abate emissions.
Management announced it had finished installing tertiary abatement technology at its Kooragang Island plant, and expects this will drive a -48% fall in the plant’s emissions. Macquarie says Orica’s approach here demonstrates a clear commercial focus in that the move will reduce its dependence on carbon credit offsets and purchases. The broker estimates the installation cost less than -$10 a tonne, implying the investment stacks up well price-wise.
However, management advises reductions will be tougher from here on out, given it is now preparing to tackle the hard-to-abate sectors in its business, given its reliance on natural gas and grey ammonia.
The broker observes the company’s coal business still constituted 14% of the company’s first-half FY23 revenue, and while down from 19% in FY19, management remains committed to the business, believing demand from emerging-market power generators will offset declines from customers in the West.
The company is increasing its end-market revenue exposure to copper.
Enter The Hydrogen Hub
Orica’s contribution to the advancement of a hydrogen hub in Newcastle is one of the company’s first moves to address the tough stuff, advise brokers.
Orica has partnered with Origin Energy ((ORG)) to build a 50MW hydrogen plant capable of producing 25 kilotonnes of potential green ammonia (7% of Kooragang Island’s ammonia production, observes Macquarie).
The project is in the front-end engineering & design (FEED) stage and management expects a final investment decision in the first half of FY24. Long term, Macquarie expects the hub will provide a low carbon feedstock (hydrogen) for the company’s ammonia manufacturing, replacing natural gas, as well as a potential alternative revenue source from green ammonia exports to Asia.
The broker suggests the new green ammonia market has the potential to offset the long-term structural decline in the Hunter Valley coal market.
Jarden appreciates the hub’s potential to derisk the ageing Kooragang plant and improve the company’s ESG profile. The broker notes the strategy not only diversifies the feedstock from gas but also the plant’s client base.
Only 80% of production is targeted for Kooragang Island, observes Jarden, with the balance allocated to Asian customers. The broker perceives this to be a good hedge should Australian and other miners be unwilling to pay a premium for green ammonia (blasting represents only a fraction of miners’ emissions).
Jarden considers the percentage replacement of grey hydrogen to be low and expects government support and or a decline in the cost of renewable energy will be necessary to scale the project. Jarden also observes that the cost of green ammonia production is -50% more than that of grey ammonia.
Brokers Have Their Say
The brokers unanimously retained their Buy or equivalent ratings post-update, and the average target price eased less than -1% to $18.00 from $18.07 previously – mainly to reflect tweaking relating to Kooragang Island and capital expenditure changes.
Macquarie believes management has demonstrated strong commercial discipline and expects strong customer demand and earnings will continue, observing that strong performances from blasting and digital technology are driving solid profits.
The broker observes Digital’s maiden segment earnings resulted in a 138% rise in its EBIT versus restated FY22 figures.
Macquarie notes the global market for ammonia remains tight, despite a fall in nitrogen prices, and observes demand from North and South America has spiked thanks to high European gas prices.
Forecasting 10% EPS growth, the broker appears to agree that FY23 guidance is achievable. Outperform rating retained. Target price eases to $17.80 from $18.00.
UBS sits slightly above consensus, forecasting strong demand from the mining industry, accelerated technology uptake, and continuing ammonia contract repricing benefits. The broker observes ammonia repricing is driving a multi-year EBIT growth outlook as supplies continue to be hit by Russian trade disruption, and suggests this is strongly supporting Orica’s recontracting.
UBS is among those expecting the company’s RONA targets are likely to be raised given they are travelling at the upper end of management’s target range.
The broker assumes a three-year EPS compound annual growth rate of 11%. FY24 and FY25 EPS forecasts rise 15%. UBS retains Buy. Target price eases to $18.80 from $19.00.
Citi also expects Orica will enjoy continued demand and operational support, forecasting improvements in both trade working-capital and operating cash flow. The broker retains its Buy rating and $17.45 target price.
Orica’s trading update slightly disappointed Goldman Sachs (which sits well above consensus). The broker lowers FY24 earnings (EBIT) forecasts by -2% to reflect the Kooragang Island maintenance outage.
But Goldman remains bullish on market fundamentals, forecasting an 18% rise in FY23 EBIT, thanks to strong mining demand, technology-driven benefits, and repricing benefits in ammonium nitrate contracts. Buy rating and $19.85 target retained.
Jarden was the least ebullient of the field.
All up, the investor day satisfied the broker, and Jarden forecasts an improvement in Orica’s three-year return on natural assets to rise given it is approaching the top of the target range. While the broker suspects the forecast El Nino may force a dilutive mix-shift from the higher margin ammonia emulsion into prill (free-flowing fertiliser pellets), its expects this will be offset by fewer blast interruptions from rainy weather.
But unlike UBS and Citi, Jarden is more concerned about contract repricing.
The broker observes FY23 recontracting mainly focussed on the repricing of Burrup’s zero-margin business, but that many more contracts are falling due in FY24.
While UBS expects this will yield a windfall for Orica, given tight markets, Jarden perceives this as a risk. Jarden retains a Buy rating and $17.10 target price and sits -4% below consensus.
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