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Morningstar | No Longer-Term Implication for Incitec Pivot from Less-Than-Expected Fiscal 2018 Earnings Increase

Our AUD 3.00 per share fair value estimate for Incitec Pivot is unchanged. The company reported a 9% increase in underlying fiscal 2018 NPAT to AUD 347 million, 10% below our AUD 384 million forecast. Underlying NPAT excludes a AUD 236 million aftertax write-down on goodwill in Dyno Nobel Asia Pacific, or DNAP, partially offset AUD 97 million restatement of deferred U.S. tax liabilities. We discern no major implications for our longer-term assumptions. Incitec Pivot’s share price fell more than 5% upon release of the result, but at AUD 4.00 remains at a material premium to our fair value estimate. Any persistence of unfavourable weather for the fertiliser business could be a key catalyst for share price convergence to fair value estimate.

The major contributor to the lower-than-expected result was the Southern Cross International, or SCI, fertiliser segment, where tonnages from Phosphate Hill plant fell 8% due to an unplanned turnaround completed in April, and dry weather in NSW and southern Queensland which hit fertiliser sales mix, volumes and supply chain costs. Overall, fertiliser Asia Pacific sales volumes fell 2.3% to 3.0 million tonnes. SCI EBITDA regardless jumped 37% to AUD 117 million with higher average realised di-ammonium phosphate and urea prices from a low base. The realised urea price increased 21% to USD 259 per tonne.

On the explosives side DNAP and Dyno Nobel North America EBITDA increased 6% and 18% to AUD 289 million and AUD 410 million, respectively, closer to expectations. The ammonia Tampa Index Price increased 11.5% to USD 292 per tonne. Higher sales volumes and more favourable mix across the businesses assisted higher average realised pricing. Strong mining activity underpinned healthy volume increases.

Our fiscal 2019 EPS forecast increases by 6.5% to AUD 0.31. The upgrade anticipates a stronger cost performance from Incitec Pivot Fertilisers, following improvement demonstrated in second-half fiscal 2018 from supply chain management.

Improved value chain management and market segmentation are expected to deliver full-year benefits in fiscal 2019. With respect to U.S. explosives, Incitec Pivot anticipates growth from quarry & construction and base & precious metals in fiscal 2019, with no planned plant turnarounds. We forecast EBITDA increasing by 30% to AUD 533 million, with continuing price improvement a key driver. Global explosives 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. In Asia Pacific, Incitec Pivot expects strong demand from the metallurgical coal sector to continue, with technology-driven sales growth gaining momentum. We forecast EBITDA increasing by 9% to AUD 315 million, price improvement again a key driver.

We have modified our group midcycle forecasts a little but to no overall impact. We now factor 1.6% revenue CAGR to AUD 4.2 billion by fiscal 2023, down marginally from our prior AUD 4.5 billion estimate. But we also assume a slightly improved 25.7% midcycle EBITDA margin from 24.4% prior, and our AUD 1.1 billion EBITDA forecast for fiscal 2023 is unchanged. The margin improvement rests largely on our upgraded outlook for SCI. Our fair value estimate equates to an unchanged fiscal 2023 EV/EBITDA of 6.6 and unfranked dividend yield of 4.0%, both discounted at WACC. Broadly speaking our fair value estimate breaks down to 70% from explosives and 30% from fertilisers. We project five-year annual EBITDA CAGR of 3.8% in explosives and 7.5% in fertiliser, the latter from a low base. We project dividends to grow at an 8% CAGR for the next five years, assuming maintenance of 50% payout ratio. But this would still be to only moderate real 4.0% fiscal 2023 yield at the current share price.