We recently researched Incitec Pivot (ASX:IPL) in The Dynamic Investor. Market interest in Incitec Pivot has recently increased after the Company made further progress on its plans to becoming a pure Explosives play. With the shares weakening following the release of FY24 results, we consider whether current levels present an entry opportunity.

About Incitec Pivot

Incitec Pivot 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. These include 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 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 estimated at 50% in North American market and 40% in Australia. In contrast, IPF is the leading manufacturer/distributor of Fertilisers in Australia, having over 50% market share on the east coast.

Key Fundamental Drivers

Still Working Towards Becoming a Pure Explosives Play

In May 2022, IPL announced its intention to de-merge its fertilisers and explosives businesses to create two separately-listed companies on the ASX. At the Company’s FY22 results release in November 2022, IPL announced its intention to delay the demerger by 6-12 months to facilitate a strategic review of the Waggaman asset. Waggaman was subsequently sold in December 2023.

The Company is now seeking a sale/closure of its fertiliser assets, having previously ceased negotiations for the sale in early July this year. Management has recommitted to completing the separation within the next six to twelve months and is now likely to occur across a number of stages. These include the exit and sale of the Gibson Island distribution centre, as well as a potential sale of the Phosphate Hill plant.

There is likely to be interest in the distribution business from other agricultural/chemical companies. However, a potential sale of Phosphate Hill appears more challenging, given the lower production profile expected in FY25 and FY26. In addition, production at the plant has reached 900Ktpa in three years out of the last ten, which is well below the both the nameplate capacity of 980Ktpa or targeted capacity of 950Ktpa.

Transformation Program an Important Step in Re-Positioning the Explosives Business

Following the appointment of a new CEO & Managing Director in January 2024, the Company announced a business transformation program to drive operational efficiency and profitability for the Dyno Nobel business. The program is aimed at improving re-contracting/re-pricing in the DNAP/DNA operations, increasing the uptake of technology by customers and improving manufacturing performance.

In FY24, IPL delivered $64m of EBIT benefits from the transformation program (or 21% of its target) and accounted for ~2/3rd of the EBIT expansion for Explosives in FY24. In context, group EBIT was $580m. The $64m of benefits achieved was greater than guidance of ~$50m EBIT. The majority of the benefits were with the Asia Pacific business. Around 40-50% of the EBIT uplift (exit run rate) is targeted by the end FY25, with ~70-80% (exit run rate) of the benefits targeted in FY26 and 100% of the benefits targeted in FY27. Importantly, the remuneration structure for IPL’s key executives matches these targets.

Around ~80% of the benefits are from improving the performance of its current business, with additional uplift from accelerating organic growth in high-value regions such as Latin America, Europe and Africa. The Company believes it can leverage its existing relationships to target growth in new markets. As an illustration, Dyno Nobel is establishing a new long-term growth supply agreement with AngloGold Ashanti, in West Africa. This agreement leverages Dyno Nobel’s strong relationship with AngloGold Ashanti in Australia.

Gearing To Increase Towards Target Level

While the FY24 earnings performance was ahead of expectations, operating cashflow was meaningfully weaker (-59%) as a result of lower earnings and a material increase in trade working capital.

However, the balance sheet is strong following the proceeds from the sale of Waggaman, with gearing (on a net debt/EBITDA basis) of 0.8x as at 30 September 2024, down from 1.2x in FY23. Given the timing of additional tax paid associated with the sale of Waggaman ($380m due in January 2025) and planned capital management, net debt at the end of FY25 is expected to rise materially. As such, the gearing level is expected to increase towards the upper end of IPL’s target gearing range of 1.0x to 1.5x.

Fundamental View

Incitec Pivot shares are currently trading on a 1-year forward P/E multiple of ~17.5x, which is above its long-term average of ~14x. This is mostly due to the market looking ~12 months ahead, when IPL is likely to become a pure-play explosives company. The Company’s earnings base is set to become less volatile following the completion of the sale of the Fertilisers business.

We contend that the current multiple is also unappealing in the context of an EPS growth profile of ~5% over FY24-27 on a CAGR basis. Although, this is weighted heavily towards a recovery in earnings in FY27, when the transformation program is completed.

We struggle to find catalysts for the shares, with the timing of the Fertilisers separation acting as an overhang, especially given that the process for separation over the next ~12 months involves several stages.

Charting View

After trending higher earlier in the year, IPL has now reached a point where it is trading sideways with no clear direction. Since the end of September, it has been stuck in a range between about $3.20 and $2.95. If we can see it close well above $3.20 then that would be a sign that it is ready to trend higher again and that would be a buying opportunity from a charting perspective. Otherwise, a break under support near $2.95 could see the stock head back towards $2.80.

 

Michael Gable is managing director of Fairmont Equities.

 

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