We recently researched Incitec Pivot (ASX:IPL) to assess the potential for a re-rating in the shares after a sustained run in commodity prices.
About Incitec Pivot
Incitec Pivot is a globally diversified industrial chemicals Company. It primarily supplies three nitrogen-based products: Explosives, Industrial Chemicals and Fertilisers. These products are supplied to a broad range of end markets, including Quarry and Construction (Q&C), Coal and Base & Precious Metals (for Explosives), industrial and specialty chemicals (for Industrial Chemicals) and agriculture (for Fertilisers).
The Company’s businesses comprise two international brands: Dyno Nobel (which include Dyno Nobel North Americas (DNA) and Dyno Nobel Asia Pacific (DNAP)) and Incitec Pivot Fertilisers (IPF).
Dyno Nobel holds the number two position in North America and Australia by volume. IPF is the leading manufacturer/distributor of Fertilisers in Australia, having over 50% market share on the east coast.
Key Fundamental Drivers
End Market Conditions Have Strengthened
In a trading update to the ASX in January 2022, the Company indicated that end market conditions remained supportive. This was largely due to favourable market conditions including strong commodity tailwinds. The Dyno Nobel North Americas segment is well leveraged to US infrastructure (via the Quarry & Construction segments) and metals demand. The US business staged an impressive recovery in 2H21, with earnings back to pre-COVID-19 levels. IPL commented that it expects Quarry & Construction volumes to grow by 3-5% in FY22. It is driven by a recovery in residential and infrastructure investment, as well as Base & Precious Metals volume growth to also growth by +3-5% on the back of elevated commodity prices and market share wins.
The Company continues to target 10% EBIT growth for Dyno Nobel overall between FY20-22, which is largely driven by earnings growth from its technology offering. Given the continued strength in commodity prices, as well as the opportunity to leverage the technology offering further (especially following the Titanobel acquisition) this estimate is likely to be conservative.
Significant Improvement in Commodity Prices
European gas prices have risen sharply after Ukraine halted all ammonia exports via the Black Sea. Further, the ammonia pipeline through Ukraine has stopped, which has impacted volume significantly. (In context, Russia is a key player in global gas and fertiliser markets, representing 22% of the global ammonia export market and 8% of global Diammonium Phosphate (DAP) exports).
As a result, prices of both DAP and ammonia have reached record highs following escalation in European gas prices and the associated export limits on Russian/Chinese nitrate/phosphate exports. The April 2022 contract price for Tampa ammonia increased by US$490/t to US$1,625/t. It is well above market forecasts of ~US$1,000/t. Based on IPL’s stated sensitivities (as at FY21), the April 2022 ammonia price increase imply an increase in EBIT of ~A$488m (i.e. assuming a US$6.6m EBIT gain for every US10/t change in the ammonia price as well as the current spot A$/US$ exchange rate). This is equivalent to ~37% of the group EBIT forecast of ~$1.3b.
European gas prices are likely to support elevated ammonia nitrate prices through 2022, especially given the likelihood of a reduction in export availability.
Input Cost Pressure is Being Well Managed
As the Company manufactures ammonia in the US, IPL’s natural gas supply at the Waggaman ammonia plant in Louisiana is priced relative to the US Henry Hub index. However, in Australia, prices are contractually fixed. After dropping by ~25% in January, over the last month, the US Henry Hub index has recovered significantly. However, the quantum of the increase is not the same as European gas prices. The significance here is that the Company’s Waggaman plant provides IPL with significant capacity to arbitrage low gas input costs (as these are priced relative to the US Henry Hub index) and high global Ammonia prices (which are sold relative to global benchmarks).
It is also worth noting that lower Henry Hub pricing provides US producers including IPL (who has ~800ktpa of nameplate capacity at the Waggaman ammonia plant) a distinct advantage. This is boosted by the fact that IPL doesn’t hedge its US natural gas costs for the Waggaman plant.
Fundamental View
There is significant upside risk to FY22 EBIT from continued strength of both DAP and ammonia prices (as the fertiliser market tightens). This is especially as earnings are well leveraged to ongoing strength in global agriculture and fertiliser pricing given that input costs are largely fixed. The strength in commodity prices also strengthen the balance sheet position. This in turn provides greater scope for growth or capital management.
Further, there is potential for earnings upgrades over the remainder of FY22 given the strong increase in spot prices. This is significant as consensus estimates are presently factoring in a 25% decline in FY23 EPS as market conditions normalise – so the continued rise in spot prices, the potential for input cost arbitrage and capital management (via share buybacks which are typically EPS-accretive) provide upside to FY23 EPS forecasts.
With the 1-year forward P/E multiple continuing to trade below recent highs as well as the average multiple over a 2-year period, we consider IPL to be a stock worth considering.
Charting View
Our previous comment on the Incitec Pivot chart on 1 February (in The Dynamic Investor report) noted that we were looking at a dip to $3 as a better buying opportunity. Since then, it managed to rally off support and break to new highs. There is some long-term resistance at $4, so it is natural to see the share price ease back from those levels. For IPL to make an attempt at breaking through $4, this current pullback needs to be fairly shallow. Ideally we would like to see IPL ease back towards $3.60 and hold that level. That would then provide the next opportunity to enter IPL. Any sharp falls under $3.60 without a bounce-back would be a negative sign.
Michael Gable is managing director of Fairmont Equities.
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