Orica (ASX:ORI) shares have endured a volatile year. Investor concerns on global macro volatility, adverse weather, and manufacturing down-time has impacted sentiment for most of the year. After the Company delivered a strong result for the 12 months to 30 September 2023 (FY23) in early November, the shares recovered well. With this in mind, we assess whether a more sustainable recovery in the share price is on the cards.

About Orica

Orica (ORI) is the world’s largest manufacturer and supplier of commercial explosives and blasting systems. The key end markets are mining, quarrying, oil & gas and construction.

The Company has global operations (across more than 100 countries) and segments its results under the following business units: Australia Pacific & Asia (APA), North America, Europe, Middle East & Africa (EMEA), Latin America, as well as its Technology-based businesses. The Company has a 45-50% share of the explosives markets within the key North America, Latin America and Australia Pacific markets. The majority of ORI’s manufacturing assets are located in Australia and it uses 3rd party supply to support its international businesses.

Key Fundamental Drivers

Plant Maintenance Dampening Short-Term Earnings

ORI delivered a strong FY23 result, with EBIT up 21% to $698m. This was marginally ahead of consensus estimates. Operating performance was underpinned by recontracting pricing benefits, sustained mining demand, and an uplift in technology adoption.

FY24 EBIT from continuing operations is expected to be higher than FY23. The key factors underpinning this expectation are continues strong demand from anticipated growth in global commodities and increased adoption of blasting & digital technology offerings. However, these benefits are expected to be offset slightly by a heavy turnaround schedule at two of the Company’s ammonia nitrate plants in Australia – Kooragang Island and Yarwun.

The estimated EBIT impact from the turnaround activity at these two plants is ~$30-40m in 1H24, as the majority of turnaround activity is scheduled in 1H24. The impact to earnings (and margin) is because ORI will have to import lower-margin 3rd party product due to 2-month loss of ammonia nitrate supply.

Contract Re-Pricing Underpin Medium-Term Earnings Growth Expectations

Looking beyond FY24, the re-commencement of the re-contracting cycle in FY25 should be a positive for FY25 EBIT. Ammonia nitrate supply continues to be impacted by Russian trade dislocations, with demand supported by increasing global mine production activity. These tight market dynamics support ORI’s ammonia nitrate re-contracting efforts.

FY24 is a thinner re-contracting year, given extensive re-contracting in FY21/22 and early FY23. ORI notes that it typically re-contracts 10-30% of book of business and FY24 likely to be towards the low end of this range. Into FY25, pricing growth is set to be supported in 2H25 by the impact of re-contracted product at Burrup (50% owned by ORI), which will be repriced with BHP in 1H25.

Digital Solutions Offering is the Growth Engine

By way of background, this segment includes Orebody Intelligence; Blast Design and Execution and GroundProbe, and is ORI’’s highest margin business.

The earnings contribution has steadily grown to become meaningful. As at FY23, the Digital Solutions segment accounted for 7% of group EBIT. This portion is roughly equivalent to the contribution from the Latin America and EMEA segments – but off a much smaller revenue base.

So, it is not surprising that ORI views this segment as the growth engine of the group. Margin has expanded rapidly, reflecting the increased adoption of its technology offering. Customers are seeking productivity gains and support on achieving their sustainability goals.

Demand for higher-margin radars is expected to grow, driven by sustainability objectives of customers globally. Growth is also expected from the broadening and integration of its sensors and software suite across Orica Digital Solutions end-to-end digital workflows. ORI will also begin to benefit from its second manufacturing plant in the US which doubles the production capacity of the business, reduces landed costs and improves speed to global markets.

Balance Sheet Scope for Acquisitions or Capital Management

Beginning in FY24, free cashflow levels are likely to be impacted by structurally higher levels of CAPEX. This trend is underpinned primarily by the increasing sustainability CAPEX initiatives being pursued by the Company. Having said that, free cashflow from FY24-26 is expected to be sufficient to support both higher CAPEX requirements and dividend payments at the current targeted payout ratio of 40-70%.

Given the strong cash generation and an already low gearing position, the Company is expected to deploy capital through acquisitions. Mining chemicals is a key target area. In the absence of acquisitions, there is potential for ORI to undertake share buybacks.

Fundamental View

ORI shares are trading on a 1-year forward P/E multiple of ~16.5x, which is below the 2-year average of ~19x and not overly demanding in the context of EPS growth forecasts of ~11% over FY23-26 on a CAGR basis.

While contract re-pricing is the key factor underpinning the attractive EPS growth profile, we consider that the heavy turnaround schedule presents downside risk to EPS growth forecasts. In particular, the Company must successfully navigate the latter in order to gain maximum benefit from contract re-pricing.

Charting View

Over the past year, we can see that ORI has formed a major support level near $14.50. At the start of November it comprehensively breached that intraday, only to rally back above it within a coupld of days. That was a bullish sign and it indicates that a low is in place. ORI recently hit some resistance near $16, so we are now seeing a slight consolidation. Ideally, a move back towards the lower part of the range near $15 would be a better buying opportunity. However, a push beyond $16 would be a positive breakout and that should lead to a new uptrend.

 

Michael Gable is managing director of Fairmont Equities.

 

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