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Morningstar | No-Moat Orica Delivers Strong 1H Earnings Growth a Touch Shy of Target. No Change to AUD 16.50 FVE

We make no change to our AUD 16.50 fair value estimate for no-moat Orica, still anticipating material margin expansion due to mix shift and cost efficiencies. First-half fiscal 2019 EBITDA expansion to 15.4% from 14.9% in the previous corresponding period highlights this potential, and we expect there is more to come. Underlying first-half fiscal 2019 NPAT increased 35% to AUD 167 million, though below our AUD 197 million forecast. Expected ammonium nitrate, or AN, price appreciation was a key driver of NPAT growth. But while underlying EBITDA increased 15% to AUD 437 million in line with our expectations, higher than anticipated depreciation and interest expense crimped NPAT. Underlying earnings excludes AUD 134 million noncash aftertax costs including Burrup plant write-downs and impairment of IT assets.

Orica says its outlook for the full financial year is unchanged although there was little in the way of numerical guidance provided back in November save for an expectation for “higher revenue and EBIT” via firming AN pricing, 3% higher global volumes, and improved plant utilisation. But the company expects earnings to be weighted approximately 45/55 across halves, and with the first half now known, full-year underlying EBITDA and NPAT in the vicinity of AUD 970 million and AUD 370 million are implied, equating to increases of 10% and 14%, respectively. This is lower than we’d allowed for and we downgrade our fiscal 2019 EPS forecast by approximately 10% to a guidance-approximate AUD 1.01 from AUD 1.11 prior. Our fiscal 2020 EPS forecast is unchanged at AUD 1.36.

We make no change to long-term assumptions. We still credit Orica growing revenue at 2% CAGR to AUD 6.0 billion by fiscal 2023, or 10% ahead of fiscal 2018 levels. We assume a midcycle AN price of AUD 1,435 per tonne (2023 dollars), little changed from fiscal 2018, reflecting oil prices at Morningstar’s unchanged USD 60 per barrel long-term forecast and Henry Hub gas prices at USD 3.00 per mmBtu.

Orica shares jumped nearly 8% on the profit announcement and at AUD 19.76 are more than 20% above December 16.45 lows. We think this too rich, the price offering a none-too-enticing 2.6% unfranked fiscal 2019 yield, and anticipating in our opinion an unrealistic five-year EBITDA CAGR of 10.8% to AUD 1.5 billion by fiscal 2023. Our fair value estimate equates to a little changed fiscal 2023 EV/EBITDA of 6.8, a price/earnings of 12.2, and a dividend yield of 4.1%. We think operational improvement can drive forecast five-year EBITDA CAGR of 7.6% to AUD 1.3 billion by fiscal 2023, 50% above what we suspect was the AUD 885 million low in fiscal 2018. This assumes strong EBITDA margin improvement to 21.5% from fiscal 2018’s 16.4%, anticipating scale benefits, cost-outs with restructuring, and mix shift. In the past five years, higher margin emulsion increased as a percentage of total AN tonnage to 62% versus 54% in first-half fiscal 2013. The Minova turnaround is also starting to deliver benefits with overhead reductions delivering a second consecutive and growing positive EBITDA print in first-half fiscal 2019.
Half-on-half net operating cash flow increased nearly six-fold to AUD 183 million. Despite this, net debt increased by 7% to AUD 1.77 billion reflecting Burrup rectification works and maintenance at Korragang Island and Yarwun plants in Australia and Indonesia. Forecast capital expenditure for fiscal 2019, including Burrup works, remains at AUD 350 million. Orica incurred AUD 189 million of that in the first half. At 38.1%, gearing remains at the low end of Orica’s 35%-45% target range, and we anticipate net debt/EBITDA to fall to 1.0 from an already nononerous 2.0 by as soon as fiscal 2020 all else being equal. This could leave room for capital management though the lack of franking credits discounts the potential for off-market buy-backs.
Beyond fiscal 2019, Orica anticipates further volume growth supported by commodity strength and mine plans. Further, Burrup plant rectification works are expected to be complete in first-half fiscal 2020. More penetration of technology-based productivity solutions is expected to continue driving margins higher.