A Rocky Start to FY18
Despite a recent hiccup from a trading update released ahead of interim numbers due in May 2018, shares of leading explosives manufacturer, Orica (ASX:ORI), have staged a partial recovery from levels seen after the fiscal 2017 results were announced. At that time, before one-off items, Orica’s reported earnings were marginally below the prior year and missed the consensus estimate. An improvement in the macro backdrop has supported the shares in 2018.
What’s New?
An update ahead of Orica’s 1H18 numbers due in May contained some unwelcome news, with several factors resulting in a forecasted lower EBIT for the six months ended 31 March 2018. This sent the shares lower in trading immediately following the announcement, but they have since recovered. The company expects a significantly stronger second half in fiscal 2018, supported by volume growth; an improved operational performance in Latin America and EMEA (Europe, Middle East and Africa); a contribution from the recently acquired GroundProbe business; and finally, business initiative improvement benefits.
Orica (ASX:ORI) announced it had entered into an agreement to acquire GroundProve in December 2017 for $205 million (with some later “adjustments”) and it closed in January 2018. The business was described as “A global market leader in the provision of critical monitoring and measurement technologies for the mining sector. Its radar and laser based monitoring systems, combined with advanced processing and analytic software, provide mining customers with geotechnical slope stability monitoring for improved mine productivity and safety. It is a profitable business with a proven track record of commercialising technology.”
GroundProbe was reportedly profitable prior to acquisition and is expected to be earnings accretive to Orica (ASX:ORI) during the first full year of ownership. Integration activities are “well underway” and the business is complimentary to Orica’s core business. The wall stability data gleaned by GroundProbe a “key data input for Blast IQ tool” making the acquisition neatly aligned with Orica’s digital strategy.
Source: Orica (ASX:ORI)
Blast IQ has delivered productivity, cost reduction, safety and compliance benefits and there has been a 34% increase in licences globally on FY18 to date.
Turning back to the update and there were several negatives, including unplanned maintenance plant shutdowns; some unexpected issues at Burrup; a continued lacklustre performance at the Minova business and some anticipated non-cash charges likely to appear in the 1H18 results.
Looking at these in more detail and Orica (ASX:ORI) said that unplanned maintenance shutdowns at its Yarwun and Kooragang Island plants is expected to impact 1H18 performance by about $17 million. The focus will be on “increasing manufacturing reliability and operational discipline and excellence.” The company expects some early improvements to flow through in the second half of the year.
Secondly, an update on operations from the company cited extreme weather in North America that has resulted in deliveries and interruptions to mine operations. Orica also referred to “continued challenges” in the cyanide market and ongoing underperformance at the Minova business. The total impact is anticipated to be approximately $15 million.
Orica’s Minova business provides chemical and mechanical earth control products, adhesives and ground support solutions for the underground mining, construction, tunnelling and civil engineering industries.
The business has faced some stiff challenges in recent years. A turnaround was slower than expected in FY17, even as revenue at the business increased 12% to $455.6 million in FY17 as sales to the Australian coal market strengthened. Minova’s EBIT increased only marginally, up $0.1 million to $13.1 million in FY17, with a divestment in China, better market conditions and ‘improvement’ initiatives offsetting each other. The unit accounted for approximately 9% of group revenue in FY17.
Source: Orica (ASX:ORI)
A new management team has been put into place and Minova has diversified into non-mining markets and expanded geographically, but the latest update is far from encouraging.
The future of the business is under review and it is expected it will incur a non-cash impairment charge in 1H18. Meanwhile, a review of environmental commitments is anticipated to result in an increase in provisions.
Orica flagged the impairment charge and provision increases to likely total around $300 million in the half year.
Another non-cash adjustment to 1H18 numbers is expected due to the lowering of the US federal corporate tax rates. This is expected to lead to a one-off restatement to the value of the company’s US deferred tax assets to the tune of roughly $55 million. Orica expects the ongoing impact from the tax reduction to be neutral.
Finally, in the update Orica stated that its joint venture partner Yara is working to address “issues related to the construction quality of heat exchangers which have shown some premature cracking”, and went on, “Whilst we do not anticipate any interruption to customer supply, there will be a one-off net negative EBIT impact of approximately $19 million for the full financial year, expected to be weighted towards the first half.”
The new plant has had a problematic history, with completion later than expected. It will service iron ore miners in the Pilbarra region and Orica has already snagged a couple of contract wins, taking business from BHP and Roy Hill away from Incitec Pivot. Due to those wins, Orica expects the Burrup plant to contribute positively to group EBIT in FY19 and be at full utilisation early in 2020.
Summary
Orica (ASX:ORI) continued to battle headwinds in 1H18, but the macro backdrop is improving and the company is leveraged to an ongoing recovery in mining activity, by being a market leader across several key segments. The company has also been investing in productivity initiatives and growth opportunities in new markets. On the valuation front, the company is currently trading on 20.4 times the FY18 forward earnings estimate, quickly falling to 17.0 times the next year. The projected dividend yield is 2.6%.
Orica (ASX:ORI) will remain held in the Fat Prophets Portfolio.
