Buy thesis remains Result above expectations due to fertiliser timing. Incitec reported underlying net profit of c.A$180m in the Mar-half, 5% above UBSe, due mostly to higher than expected DAP volume sales in the period. All other divisional earnings lines were broadly in line. UBSe EPS cut by 2-4% over the next 2 years. Our new earnings estimates see 20% growth in net profit in the 2H, and c.5% in FY12. This is driven mostly by explosives, which we expect to make-up 55% of group EBIT next year, and is driven a 15% rise in underlying Dyno earnings, first production from the Moranbah plant and the final year of Project Velocity savings. Partly offsetting this is the 8% negative impact from lower DAP forecasts. Valuation remains attractive. Our A$4.70 per share valuation implies a FY12 PE of 11x, struck off a US$530/t DAP price falling to US$400/t by FY14. We believe the stock?s c.15% relative underperformance to the Industrials since its mid-Feb highs is overdone, which also sees Incitec trading at a near time low versus Orica, see chart below. Notwithstanding the recent sell-off in commodity linked stocks, we continue to see a generally positive outlook for Incitec?s earnings over the next few years driven by tight outlook for corn stocks, which should be positive for fertiliser demand and pricing and continued recovery in North American explosives. Bear case DAP scenario still produces 30c of EPS in FY12E. Using a bear case DAP price forecast of US$400/t in FY12+ results in a 15% reduction to our earnings estimates, but still produces 30c EPS next year, implying 13x our FY12 EPS. The US$400/t DAP forecast assumes phosphate industry margins for integrated producers falls back to their long term average of US$100/t, and is struck of a merchant rock price assumption of US$60/t versus current spot of US$160/t
Key result highlights Net profit was c.20% above last year, and c.5% above UBSe of A$171m. This was due mostly to higher than forecast DAP sales (A$20m or c.20% above UBSe) and lower cost to serve Moranbah customer volumes (A$9m or c.10% ahead) in the 1H. Dyno North America and Incitec Pivot Fertilisers (IPF) both reported in line results. FY11 forecast implies a c.65% skew in the 2H. We now expect Incitec to report net profit of c.A$550m in FY11, implying c.A$360m in the Sep-half. Key drivers of our full year forecasts are outlined below. Fertiliser EBIT increased c.45%. The division reported EBIT of c.A$140m, up from A$100m last year, driven mostly by higher realised DAP and urea prices, partly offset by lower volumes due to cyclone Yasi and the Gibson Island shutdown. Explosives growth driven by North American recovery. Dyno reported a 10% rise in EBIT. Within this Asia Pacific was up 3%, while North American earnings were up 20%. In US$ terms NA was up c.30%, driven by a 9% increase in volumes, incremental project velocity savings and higher nitrogen pricing. Moranbah start-up delayed to Jun-qtr. First production is now not expected until end-June 2012, compared to previous guidance of the Mar-qtr. Although the project remains on budget at A$935m, due to financial contingencies built into cost projections. Cashflow higher than last year, but weaker than UBSe. Cash conversion to EBITDA on a pre-tax ungeared basis was just 30%, reflecting a significant lift in Fertiliser trade working capital of A$187m. Capex. Net capex of A$280m was c.20% above our forecasts due mostly to sustenance spend relating to the GI shutdown, partly offset by lower than anticipated Moranbah capex. We expect capex of A$270m in the 2H, and A$435m in FY12 driven by Moranbah and the new AN emulsion facility in WA. Net debt. Net debt increased to A$1.4bn at end-March, up from A$1bn at Sep- 2010. We expect net debt to remain broadly flat in the Sep-half, and progressively falling from FY12. Hedging increased in FY12. Transactional hedging was increased to 95% of fertiliser sales at 92c in FY11, while 75% of FY12 DAP and urea sales have also been hedged at 98c, with full participation down to 90c.
Earnings revisions Our net profit forecasts fall by 2% in FY11 and 4% in FY12 to reflect the following changes: Fertilisers. Total Fertiliser EBIT falls by 5% in FY11 due to higher cash production costs this year, reflecting higher sulphur input costs, and higher depreciation. FY12 forecasts rise 2% reflecting the impact from more favourable hedging. Explosives. Dyno EBIT increases by 5% in FY11, driven by lower costs to serve the Moranbah customer contracts. FY12 forecasts fall 5% reflecting the delay of start-up at Moranbah until June-2012. FX. We are using an effective currency rate of 103c for Dyno and 93c for fertiliser earnings in the Sep-half, which includes the impact from hedging. Management has also hedged 75% of fertiliser sales at 98c in FY12. Interest costs. Our net interest forecast increases over the next 2 years due to higher net debt balance and slight increase in effective interest rate.
Explosives to offset lower DAP from FY12 Explosives uplift expected from 2H11. The Dyno explosives businesses reported a 10% lift in A$ EBIT through the Mar-half, although this was c.25% after removing the impact of currency. The result was again driven by incremental benefits from Project Velocity and a net benefit from the Moranbah provision release. Underlying earnings were down on last year, impacted by the Queensland floods through the half. We expect Dyno?s contribution to EBIT to rise over the next 2yrs driven by lower fertiliser prices and the following: Underlying growth of c.8%pa. Removing the impact of currency, Moranbah impacts, and Project Velocity we are forecasting EBIT growth of 8%pa in FY12 and FY13. This is mostly driven by volume and price recovery in North America, and rebound in Australia following the A$16m impact from the Queensland floods through the 1H. Project Velocity. We expect further incremental savings of US$65m by FY12, which is as per guidance, and likely to be achieved through volume related efficiencies such as manufacturing optimisation and better procurement. Moranbah. Start-up of Moranbah is now expected from end-June 2012, with the plant only expected to add A$11m in the Sep-qtr. We expect this to ramp up to A$160m by FY15. Moranbah provision release. We expect the net benefit to EBIT to fall in FY12 to A$43m, from c.A$50m this year. However, this is expected to increase in FY13+ once the Moranbah plant begins production.
Moranbah to drive Australasia growth Moranbah forecast changes. We expect Moranbah to begin production in the Sep-qtr 2012, with gradual ramp-up in production through FY15. The delay negatively impacts our group net profit forecast by 6-7% in FY12. Moranbah is expected to account for c.17% of group EBIT over the next 5 years and achieve a net return of around c.16% by FY15, although this becomes c.17% on a capital base of A$935m, close to management?s target of 18%. Asia Pacific up side in Indonesia and WA also remains. We see further growth for Dyno in Australasia through opportunities in both Indonesia and WA. We are now factoring in first production from Dyno?s A$40m 100ktpa Pilbara emulsion plant from FY12. We see the plant delivering around c.A$10m EBIT contribution from FY13+, implying a pre-tax return of over 20%. Moreover, we also see Dyno increasingly leveraged to growth in Indonesia, where it is now the second largest player with marketshare likely around c.10% over the next 12 months. We see the South East Asian market undersupplied by around c.300ktpa despite Orica?s Bontang plant coming on-line by end-2011, highlighting the opportunities to all players. While the likelihood of Dyno building Greenfield AN capacity in the region is relatively small, we believe it can leverage niche opportunities, such as the growth in emulsion demand, with relatively small incremental capital investment.
Fertilisers earnings drivers Total Fertiliser EBIT was A$139m, in line with our estimates and c.30% above the pcp. This was driven by a significant increase in average global DAP prices, partially offset by reduced volumes in the IPF distribution and SCI manufacturing businesses as a result of floods and a change in timing of sales. Following today?s result, we expect fertiliser earnings to continue to improve through FY11 driven by: Higher domestic sales. Almost all DAP sales in the 1H were executed in the domestic market. While we expect this trend to normalise in the 2H, we are still expecting c.550kt to be sold in Australia in FY11, a 20% rise on FY10. This trend will be an important margin driver as Incitec has traditionally achieved a cA$100/t price premium on domestic sales. Base business to benefit from improved conditions. As expected, 1H11 sales in Incitec?s domestic distribution business were weak, however we still expect total distribution volumes to reach 2.1mt in FY12. This is reflective of the ongoing recovery in domestic agriculture demand and the impact of higher soft commodity prices. Short term support for DAP prices. Volume sales of DAP were affected at an average DAP price of US$588 fob Tampa, compared to US$591 average for spot. Current spot has settled around the US$615 with demand out of India offsetting a sluggish US environment. We are forecasting that Incitec will sell 560kt of DAP in the 2H at an average sale price of US$620. Our FY12 and FY13 DAP forecasts are US$530 and US$450 respectively before falling to US$400 from FY14+
Capital and cashflow Incitec generated cA$100m of ungeared operating cashflow in the 1H, flat on last year and well below our forecasts. Adjusted EBITDA cash conversion was weaker than expected, coming in at 33% compared to 60% in the 1H10; we expect this to increase to 80% for the full year, below the 90% conversion in FY10. The weaker cashflow result can be attributed to a significant increase in working capital as Incitec looked to build inventory volumes on hand ahead of an expected strong Australian winter application season. The value of these inventories also rose as import prices in the 1H were higher than last year. Total capital expenditure in 1H11 came in at cA$280m versus cA$80m in the pcp, due mostly to a higher Moranbah spend of A$143m (A$5m in the 1H10). The remaining capital required for Moranbah is now cA$390m which will be split evenly between now and Jun-12; post FY12 both sustenance and growth capex are expected to normalise at cA$250m. The higher capex and working capital saw net debt increase A$260m from Sep-10 to cA$1.4bn, with A$1.1bn of un-drawn committed facilities remaining. Despite the higher capex and working capital, Incitec?s gearing metrics remain comfortable in our view with net debt / EBITDA staying around 1.6x, while EBIT interest cover is sustained around 11x through FY12.
IPL Price at posting:
$3.87 Sentiment: Buy Disclosure: Held
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