Having reached a recent high of $18.69 per share in early December, shares in Orica (ASX:ORI) retreated on the back of several factors impacting investor sentiment. These include: i) Potential downside risk from negative revisions to FY26 consensus over the next year, from a slowing re-pricing cycle for ORI, ii) Uncertainty regarding the outcome of the Company’s review into its capital management policy and iii) Lower-than-expected earnings contribution/integration challenges from recent acquisitions.

We recently researched ORI in The Dynamic Investor to assess whether the recent weakness presents an entry opportunity.

About Orica

Orica is the world’s largest manufacturer and supplier of commercial explosives and blasting systems to the mining, quarrying, oil and gas and construction markets. The Company also supplies sodium cyanide for gold extraction and provides ground support services in mining and tunnelling.

Following recent acquisitions, ORI is now the world’s largest explosives company. It is also the global leader in geotechnical and structural monitoring in mining and civil infrastructure. The Company also has a leading technology offering.

ORI now reports across three core segments: Blasting Solutions (core explosives business), Digital Solutions (including the Terra Insights acquisition), and Specialty Mining Chemicals (integrating the Cyanco acquisition).

The new segment reporting highlights the Company’s strategic shift from a traditional explosives company to a diversified mining solutions provider. Also, separate reporting of financials for the Digital Solutions and Specialty Mining Chemicals segments provides greater insight into these high-growth areas.

Key Fundamental Drivers

Strong Earnings & Margin Outlook

The Company is targeting double-digit earnings growth (at a group level) over the next few years. Consensus estimates are factoring in +20% growth in FY25 (compared to FY24). Earnings growth for FY25 is driven by an improved product mix and higher pricing as the recontracting cycle gets under way.

Also aiding earnings growth in FY25 and beyond will be greater contributions from its recent acquisition of Terra Insights. The latter is a geotechnical and structural monitoring hardware and software provider.

Margin mix continues to be a key focus with tangible earnings benefits from the take-up of value-added products and tech solutions. These continue to gain good traction given productivity focus of the miners.

Pricing Growth Expected

Orica is positioned to benefit from pricing growth in domestic ammonium nitrate (AN) markets and further penetration of value-added products. Australian AN pricing is robust due to an AN supply/demand imbalance. The latter supported +11.5% EBIT growth in FY24 for the APA operations. But, unlike the recent re-contracting cycle, the next re-contracting cycle will be underpinned by additional factors such as services, technology and premium products.

Into FY25, ORI will benefit from its largest customer contract (equates to 50% of capacity) being renewed on more favourable terms. FY25 pricing is also expected to benefit from the lower A$ vs the US$. Whilst a weaker A$ in part reflects slower global economic growth and commodity prices, recent A$ weakness has also been driven by US$ strength following the Trump election win. ORI has foreign exchange exposure to 38 different countries, but its two largest exposures are the US$ and Canadian dollar. A weaker A$ (vs these two currencies – especially the US$) results in an earnings benefit (as ORI reports results in A$ and generated 62% of revenue outside of APAC in FY24). In addition, it also increases the AN price in Australia which, at the margin, is a tailwind to pricing locally.

With a persisting AN supply/demand imbalance in Australia, another cycle of price increases implemented by the Company from FY26 is likely to be difficult, particularly as capacity additions in Western Australia come online in FY26.

If AN recontracting growth slows, the primary driver of ORI’s earnings in APA would shift to value-added products, particularly wireless technologies. To achieve better pricing on contracts, ORI needs to maintain its competitive technological advantages over explosives provider peers. Having said that, the adoption of ORI’s premium blasting products and technology is only in its infancy given it was delayed during COVID and in some regions.

Balance Sheet Provides Scope for Capital Management

With the gearing level now below the target range of 30-40%, the Company has flagged the potential for capital management, including a share buyback. The Company is expected to release an updated capital management policy at its interim results release in May. Aside from a share buyback, there is potential for a higher dividend payout ratio, given expectations for strong free cashflow in FY25 as recent acquisitions begin to contribute.

The Company’s review of its capital management policy will also consider its target gearing range. Recent acquisitions and relatively flat CAPEX commitments are likely to boost free cashflow over the medium term, which underpin expectations for gearing to decline over the medium term. Accordingly, there is the possibility that the target gearing range is increased as a result of the Company review. In turn, this would facilitate a larger share buyback. As an illustration, a large-scale share buyback of $1.3b would take gearing to ~35%, which would be in the middle of the current target gearing range.

Fundamental View

We consider that there is potential for a re-rating from current levels in light of prospects for further capital management initiatives (albeit not expected until May), as well as the market placing greater weight on the potential for margin expansion over the medium term. The latter is expected to come from pricing growth in domestic AN markets and further penetration of value-added products. To this end, consensus estimates are not factoring in a material step-up in group EBITDA margin over the medium term.

ORI shares are now trading on a 1-year forward P/E multiple of ~16x, which is at a discount to both the 2-year and 5-year average of ~17.5x and ~18.5x, respectively. In addition, the current multiple is not overly demanding in the context of an EPS growth profile of 12% over FY24-27 on a CAGR basis.

Charting View

In the past several weeks, Orica has fallen back towards support near $17, and is now trading under it. From a charting point of view, we would like to see it get back above $17 and demonstrate that there is strong support here. That is, wait for a close above $17 to trigger the next buy signal.

 

Michael Gable is managing director of Fairmont Equities.

 

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