After reviewing Incitec Pivot (ASX:IPL) last month, we moved to a Buy recommendation on account of an improving outlook for DAP and ammonia prices, to which the share price is highly correlated to. Aside from more tangible evidence of an improvement in fertiliser prices, what are the are other factors supporting a more positive view on IPL? More importantly, can these support a further re-rating in the shares?
About Incitec Pivot
Incitec Pivot (IPL) is a globally-diversified industrial chemicals Company and 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, while IPF is the leading manufacturer/distributor of Fertilisers in Australia, having over 50% market share on the east coast.
Factors Underpinning the Potential for Group Earnings Growth
The Company’s financial results for the 12 months to 30 September 2020 (FY20) were below market expectations due to lower earnings in Dyno Nobel Americas, where ongoing COVID-19 disruption drove lower coal/metals ammonia nitrate volumes.
However, looking beyond the FY20 results, we outline a number of factors underpinning expectations for a strong recovery in earnings growth in FY21 and FY22:
1. The recovery in global fertiliser prices (DAP/ammonia) which underpin the likelihood for a strong recovery in earnings for the Fertiliser division in FY21/22 based on more normalised fertiliser prices. The more positive outlook for fertiliser prices is underpinned by improving global agricultural conditions, capacity management and trade flow redirection. Over the medium term, IPL flagged supply/demand dynamics in ammonia markets could continue to tighten given the lack of new supply coming to the market.
2. Ongoing strength in domestic fertiliser demand volumes, supported by a favourable 3-month rainfall outlook for February to April 2021.
3. Improved ammonia nitrate volumes. In particular, IPL is expecting 10% EBIT growth for Dyno Nobel overall between FY20 and FY22.
4. Cost savings benefits, where IPL is expected to deliver cost savings of $60m per annum by FY22 ($30m to be delivered in FY21 with $20m of this to come from the Fertilisers division). These cost savings are in addition to the targeted $40-50m of manufacturing efficiencies by FY22 through improving its plant reliability.
5. The Company’s enhanced technology offering has resulted in market share gains in Asia Pacific and benefitting from continued conversion to premium Electronic Detonators Systems in Americas.
The recovery in earnings is likely to be weighted towards FY22, as earnings in FY21 are expected to be impacted by plant shutdown and maintenance activity at four manufacturing plants (Moranbah, Waggaman, Mt Isa and St. Helens), as well as the appreciating A$ and higher gas prices. Importantly, the EBIT impact from the four plant shutdowns in FY21 is expected to unwind in FY22.
What are the Risks to Earnings?
Management execution on the plant turnarounds in FY21 is a key risk, especially as management execution in the past has been a major drag on the Company’s fundamentals. In particular, the Company issued about six negative trading updates in FY19, some of which related to production/capacity challenges at its ammonia nitrate plant in Waggaman.
However, there has noticeable improvement in the Company’s asset performance over the past 18 months, which were achieved without major unplanned disruption/production impacts. Should IPL successfully work through the upcoming plant shutdowns without significant issues, then it would increase market confidence that the Company can achieve its 95% reliability target in FY22, thereby not negating any of the earnings benefits expected in FY22.
With the recovery in earnings weighted towards FY22, IPL is trading in a FY22 P/E multiple of ~17x, having re-rated from ~15.5x since our research report on the Company last month. While the current multiple is above the average 1-year forward P/E multiple over the last two years, we still consider IPL to be a stock worth considering.
IPL’s share price and earnings are significantly influenced by DAP and ammonia prices, which have finally found some support after a lengthy period of underperformance. Therefore, it is likely to provide share price support over FY21.
Our previous commentary in early November in The Dynamic Investor noted the tightening range and we commented that IPL “should continue to rally from here. There will be some natural resistance near the April peak at $2.40. If it can push beyond that, then the next major line of resistance is up near $3.20.” We saw IPL rally to just over $2.40 in November before consolidating once more. A few weeks ago, it broke free again and the shares are once again on the move. Any short-term consolidation and reversal back near $2.40 would be a new buying opportunity and our target remains up near $3.20.
Michael Gable is managing director of Fairmont Equities.
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