ORI

From Sanfords report 24/09
Value enhancing chemicals trading business growth.


ORI has agreed to acquire the Fernz Specialty Chemicals (FSC) trading business from Nufarm for A$60m effective 31 October. While small in the context of the ORI group, the transaction represents a substantial growth initiative for ORI’s Chemnet business which has earned the right to grow (current RONA of c34%). We expect good cost synergies (>$5m annually) and working capital reduction (>$10m) to be achieved.


We expect the transaction to achieve NPAT accretion of c$2.5m, normalised NPAT accretion of c$4.2m, and RONA of c20% in FY 04.


We view the FSC acquisition as a low risk value enhancing growth initiative for ORI.
Event


One year after Malcolm Broomhead became CEO of ORI, the company’s businesses are beginning to fall into the following three categories: (a) Those that are unable to meet the 18% RONA target, such as CropCare which is being divested; (b) Those that require some work (which is currently underway) to achieve the RONA target such as North American Mining Services and Fertiliser; and (c) Those that are beating the RONA target and have earned the right to grow. Chemnet, which is the leading importer, distributor and trader of chemicals in Australia and NZ with annual sales of $400m and assets of $95m, falls into this third category. We estimate Chemnet’s EBIT/sales margin to be 8% and its RONA to be 34% – which we believe would rank the business as one of the industry’s top performers. The FSC acquisition will boost Chemnet’s annual sales by some $190m and should allow significant synergies to be achieved with respect to both operating costs (>$5m annually) and working capital (we estimate savings >$10m). We expect the FSC acquisition to be about neutral to ORI’s NPAT in FY 03 and about 1.0% (or c$2.5m) accretive to NPAT in FY 04 after both funding costs and goodwill amortisation. We also expect the acquisition to be about 0.6% (or c$1.6m) accretive to ORI’s normalised NPAT in FY 03 and 1.6% (or c$4.2m) accretive to normalised NPAT in FY 04.

Impact


We maintain our ORI estimates of $210m for FY 02 and $240m for FY 03. However, we have increased our earnings estimate to $252.5m for FY 04 (from $250m).

Valuation


Our ORI valuation/price target is $11.00/share. We value the operations at $10.85 using a normalised PER of 13.5x for FY 02E and the surplus property and a likely tax refund at $0.15.

Action


We believe ORI’s earnings visibility and momentum (238% growth in FY 02 followed by a CAGR of c10% in the next two years), significantly improving returns, and low valuation multiples are attractive. ORI is one of our top basic material picks. Buy.
Additional Information


With import distribution of more than 350,000t of chemicals annually and significant investments in strategic supply chain assets, Chemnet is the leading supplier of chemical products and specialist services to industrial markets in Australia and New Zealand. It sources chemicals from over 200 different manufacturers in 50 different countries in order to supply products and services to thousands of customers throughout Australasia. Chemnet supplies a broad cross section of the economy and hence its sales are relatively non-cyclical. FSC’s markets are complementary and include health care, foodstuffs, polymers, pulp and paper, and water and waste water.

Source: Company reports


We believe the FSC acquisition is a very sensible one for ORI to make. Chemnet has earned the right to grow with its returns being well above ORI’s 18% RONA target. Chemnet has a track record of consistent earnings growth and it has strong competitive advantages (including scale, low costs and supply chain efficiency).


Financially, we expect FSC to meet or beat ORI’s targets. The original purchase price for FSC of $60m represents an EV/EBIT multiple of 12.0x based on FSC’s current EBIT of $5m and we estimate goodwill of $11-12m (comprising the excess of $8m paid above FSC’s book value as well as implementation costs of $3-4m). However, we believe significant synergies will be achieved through a combination of increased purchasing power, improved supply chain efficiencies, and reduced administrative costs and overheads. ORI expects annual synergies of at least $5m to be achieved during FY 04. Additionally, we believe Chemnet’s supply chain competencies should help to lower FSC’s working capital (currently 24% of sales vs Chemnet’s 14%) which would potentially free up cash of $10m or more. We therefore expect FSC to achieve EBITA of approximately $10m on capital employed of around $50m in FY 04E. The resultant EBITA/capital employed of 20% would exceed ORI’s RONA target.


The Australasian chemicals trading market is approximately $8bn in size and it has been growing over the past five years at a CAGR of >8% (see Chart 1 below). The market is very fragmented with the major players comprising Chemnet ($400m sales), FSC ($190m), Amtrade ($150m), Bronson & Jacobs ($150m), and parts of Asia Pacific Specialty Chemicals ($100m). We expect it will take Chemnet no more than 12 months to successfully integrate FSC and we believe that there would be scope for the business to continue to grow both organically and through additional "bolt on" acquisitions.

Investment Risks


ORI is exposed to raw material cost increases (ammonia, oil, titanium dioxide) which are, at times, difficult to pass on. The company’s earnings are also sensitive to international commodity prices (ammonium nitrate, urea, resins, and caustic soda), weather influences (on the agricultural chemical operations), domestic/international economic activity, and competitive influences.