EUR 850.00 For Business Accounts Only

Morningstar | Incitec Pivot Strengthening Customer Relationships Through Technology

We make retain our AUD 3.00 per share fair value estimate for explosives company Incitec Pivot, despite lowering our fiscal 2018 EPS forecast by 8% to AUD 0.23 from AUD 0.26 following guidance provided at the company’s investor day. No-moat Incitec Pivot doesn’t provide explicit earnings guidance but revealed enough to prompt some reining-in of our short-term earnings expectations. Fiscal 2018 has been affected by a mechanical turnaround at the Phosphate Hill plant taking longer than expected, and persistent drought conditions in New South Wales and Queensland are taking their toll. We don’t think any of these will be sufficiently long-lived to affect our fair value estimate, but trading at around AUD 3.80, Incitec Pivot shares remain materially overvalued, and earnings disappointment could be a key catalyst for a share-price retracement towards fair value.

While we are reducing our fiscal 2018 EPS forecast, AUD 0.23 still represents a 20% improvement on fiscal 2017, anticipating in particular a stronger performance from the Americas, where explosive earnings are expected to be up on the previous corresponding period, and agriculture and industrial chemicals are also anticipating improved urea prices. Global fertiliser prices are kicking up from at or near cyclical lows in 2017, and the emergence of stronger prices is in line with our forecast. The Americas now account for 50% of group EBIT.

Our group midcycle forecasts are little changed, including a 4.6% revenue CAGR to AUD 4.3 billion by fiscal 2022, at a 24.5% midcycle EBITDA margin. Our fair value estimate equates to a fiscal 2022 enterprise value/EBITDA ratio of 6.5 and unfranked dividend yield of 4.1%, both discounted at the weighted average cost of capital. Broadly speaking, our fair value estimate breaks down to 75% from explosives and 25% from fertilisers including Southern Cross. We project a five-year annual EBITDA CAGR of 6.5% in explosives and 8.0% in fertiliser, with the latter from a low base.

We project dividends to grow at an 11% CAGR for the next five years, assuming maintenance of a 50% payout ratio. However, this would still be to only moderate nominal 5.0% fiscal 2022 yield at the current share price. The unchanged dividend policy is for a 30%-60% payout ratio.

Our growth projections for Incitec Pivot rest substantially on it successfully leveraging its technology offering. A focus on innovation and superior products has delivered solid outcomes in the past and is expected to continue doing so. The main goal is to improve both productivity and safety. In explosives, this rests substantially upon advanced initiating systems and the Differential Energy (Delta E) offering, which tailors the blast result across rock strata. Delta E is well established in the Americas, representing 40% of Incitec Pivot’s load-out fleet, but has only recently been launched into Asia-Pacific, where early customer feedback is regardless positive. In fertilisers, stabilised products that reduce losses to the environment are a differentiator.

Incitec Pivot’s explosives business is strategically short ammonium nitrate, or AN, production capacity by around 200,000 tonnes in a long-capacity market. We think this is sensible, with plants sold out and consequently running at high efficiency. A superior product offering is essential to facilitate this strategy, with demand supported by flexible third-party agreements that are footprint-logical. AN markets across Australia are not expected to balance until 2021, and only then will expansion opportunities including at Moranbah be assessed.

Improved group free cash flow available from fiscal 2019 is expected to be allocated to debt reduction following major construction programs in recent years, including AUD 1.0 billion on Moranbah and AUD 1.0 billion on Waggaman. Incitec Pivot says Waggaman is on track to meet its 15% internal rate of return, or IRR, investment hurdle, and the U.S. ammonia plant has run at 105% of nameplate capacity in 2018. Group net debt stands at AUD 1.7 billion, down from AUD 2.1 billion at end March, with net debt/EBITDA at around 1.8. We project this to fall to a more comfortable AUD 1.0 billion and around 1.0 times by early fiscal 2021, barring unforeseen acquisitions.