By Andrew Blackmore
What's new?
While the trading update that fertiliser and explosives maker Incitec Pivot released early last month was a mixed bag, in Fat Prophets' view the key negatives were issues that have previously been flagged by management. Consequently, these earnings headwinds should already be priced into the stock.
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At any rate, on balance, we believe that these negatives are now being offset by a growing list of positive earnings tailwinds, which bodes well for potential share price appreciation from current levels.
Signs are good for a potential share price appreciation.Credit: Greg McKenzie
Taking a look at both sides, the negatives include the lower gas supply at the Moranbah plant (although this is not expected to persist past 2016), falling coal production in North America, volume and margin pressures in the Australian explosives business (due to resource industry weakness) and some margin pressure in the broader fertiliser business.
On the positive side, the Phosphate Hill fertiliser plant is running smoothly, and based on the current run rate is on track to produce one million tonnes this year – a record production level.
In the explosives business, while coal production is in decline, construction activity is enjoying robust activity and is a higher margin business for Incitec Pivot.
We continue to have a positive view on US residential construction; with most indicators favourable and new home starts activity still well below long-term averages.
Outlook
The key to Incitec Pivot's investment case, in Fat Prophets' view, is that the Louisiana ammonia plant is on track, both from a budget and schedule perspective, to provide Incitec Pivot with increased earnings diversification and an attractive medium-term growth kicker.
As per Incitec Pivot's recent trading update, the project is approximately 85-90 per cent complete, with commissioning expected in 3Q16. The prospect of cheap gas to fuel the ammonia plant and the weaker Australian dollar versus the US dollar should help ensure a positive outcome for Incitec Pivot's shareholders.
Compared with when the company initially committed itself to the deal, the repatriated earnings from the new plant are now likely to be worth about 30 per cent more.
At any rate, management expects the new plant to deliver an internal rate of return in excess of 15 per cent and have a payback period of less than five years – both are strong metrics for the industry.
Price
Incitec Pivot is currently trading at a price-to-earnings ratio of 14.1 times FY16, with this falling to 11.1 times FY17 due in part to contributions from the Louisiana plant, while the prospective dividend yield is sitting around 3.5 per cent. In addition to Incitec Pivot's solid fundamentals, the company's technical outlook has also turned positive with a break-out above both daily averages.
Worth buying?
Incitec Pivot's long-term growth outlook is primarily linked to two engines – the US economy and the industrialisation of Asia. While most (including Fat Prophets) have a fair amount of confidence in the former, some are more sceptical regarding the Chinese leg of the Asian story.
It has been reported that Incitec Pivot's chief executive James Fazzino remains of the view that the current slowdown is not the end of the Chinese growth story and we concur.
Even though Chinese GDP growth rates might slow from prior levels, they remain high by global standards and the economy is growing from a much larger base than a decade ago.
In essence, Fat Prophets remains of the view that China, and other parts of Asia, will continue to contribute meaningfully to the global economy in the years ahead, with some short-term dips along the way. As such, we believe that Incitec Pivot offers good value at the current price.
Andrew Blackmore is a senior analyst at investment research and funds management house Fat Prophets. Click here to receive a recent Fat Prophets Report.
Disclosure: Interests associated with Fat Prophets declare a holding in Incitec Pivot.