Mac Bank ResearchStock: IPL AU Recommendation: Outperform...

Mac Bank Research

Stock: IPL AU
Recommendation: Outperform

Event

We have conducted a survey of eastern Australian fertiliser buyers to gauge current trading conditions for Incitec Pivot (IPL).

Impact



Conditions remain mixed across eastern Australia but expectations are for a better crop than last year. Seasonal conditions remain patchy in NSW, and average in Queensland (Qld) with fertiliser volumes matching last year. This means that further upside requires strong top-dress urea sales, which in turn depends on spring follow-up rains. The cotton outlook is very weak with zero water allocation, and low dam levels which will negatively impact IPL's high margin Big-N sales. IPL is still more exposed to fertiliser prices than volumes.

The DAP price is soft at US$1155/t (FOB Tampa). Latest spot sales in India are at $1073-1100/t cfr (inclusive of freight). On an equivalent basis the FOB Tampa price would be around $1000-1050/t. Indian demand is strong with imports of some 4.3-4.5mt for 2008 (assuming a 12% growth rate in DAP application). However, DAP demand in Pakistan and Latin America is soft with some demand destruction evident. Part of this is timing related with 3Q historically a seasonally weak quarter for fertiliser prices. Looking forward Brazilian DAP imports of +1mt are expected in 4Q (summer crop planting) and US winter wheat demand should emerge. We note the cash cost for wholly unintegrated DAP producers is US$1200/t which should support the DAP price floor remaining at high levels (ammonia stronger, sulphur weaker). We currently forecast an average DAP price of US$950/t in FY08 and US$1049/t in FY09. Our urea price forecast for FY09 is very conservative at US$400/t (versus spot of US$800/t).

A lower A$ is positive for IPL by increasing import parity fertiliser prices (DAP, urea) which in turn sets the domestic fertiliser price (it is the A$ DAP and urea prices which is key for IPL). Inclusive of Dyno translation benefits, we estimate a 1c reduction in the A$:US$ represents +$14m in EBIT (1.1% ch in FY09 NPAT). IPL's average FX in FY08 was around A$:US$0.93. A $0.10 A$ movement (to A$:US$0.83) would equate to a $140m EBIT benefit versus our A$:US$0.90. Our FY08 NPAT of $644m is well above consensus of $574 as we factor in lower FX and a 2H seasonal improvement, both of which are too aggressive. Our $872m FY09 NPAT is similar to $862m consensus with potential 10%+ upside based on lower A$ and higher urea.

Earnings Revision



No change.

Valuation, target, catalyst

Due to research restrictions, Macquarie can not advise its valuation on IPL at present.

Action and Recommendation



We retain our Outperform recommendation with a $190.76 target price (DCF valuation). Global fertiliser share prices have been very volatile in line with the oil price. Near-term DAP price fundamentals are weakening but this is offset by a lower A$ which is positive for IPL's earnings. A lower A$ highlights the positive timing of the $3.4bn Dyno acquisition (85% US earnings). IPL remains a strong cashflow generator with an estimated FY09 free cashflow yield of 10.3% and 5.5% pre and post Moranbah capex.