Some better news
Shares of Incitec Pivot (ASX:IPL) have staged a recovery in recent weeks as the company reported a contract win in West Australia that will mitigate the earlier loss of two other contracts. The company also inked a deal for gas supply to the Gibson Island plant that although this will see costs go up, the change was in line with management’s earlier guidance.
1H18 review (A$ unless otherwise noted)
Group revenue increased 9.6% year-on-year to $1,683.2 million. All businesses contributed to the increase, with Dyno Nobel Americas (DNA) revenue leading the way with a 14.7% increase in Australian dollar terms to $677.8 million. The Fertilisers business was the second largest contributor and revenue ticked up 5.2% to $557.1 million, while Dyno Nobel Asia Pacific chipped in $479.1 million, up 7.7%. The negative contribution to group revenue from the Elimination and Corporate line increased 4.1% to $30.8 million in 1H18.
There was strong demand in the US and Australian explosives markets, but the fertiliser business was impacted by dry weather across eastern Australia.
Group EBIT (earnings before interest and tax) excluding IMIs (individually material items) decreased $2.5 million, or 1.0% year-on-year to $240.3 million.
Commodity prices, plant efficiencies at the Moranbah and Waggaman operations were positive factors, while foreign exchange movements and some maintenance were negative factors. The following table outlines the impact these key factors had on EBIT excluding IMIs.
Source: Incitec Pivot (ASX:IPL)
The EBIT margin fell 1.5 percentage points year-on-year to 14.3% in 1H18. Net borrowing costs increased from $49.9 million to $59.7 million, primarily due to higher average US interest rates and the cessation of interest capitalisation relating to Waggaman. Tax expense decreased $8.3 million to $31.4 million, with the decline largely linked to the cut in US tax rates.
Net profit after tax (NPAT) excluding IMIs of $147.1 million represented a 3.3% decline from a year earlier. Statutory NPAT for 1H18 came in at just $7.6 million compared to $152.1 million in 1H17. The sharp drop was due to net individually material items expense of $139.5 million. That represented a non-cash write-down of $236 million on the goodwill of the DNAP business after the company lost contracts from BHP and Roy Hill and other factors, partially offset by one-off non-cash benefit of $96.5 million from the restatement of the US deferred tax liabilities.
The company declared an interim unfranked dividend of 4.5 cents per share, effectively maintaining its pay-out ratio at 51% of NPAT excluding IMIs.
Net debt of $1.74 billion was about flat compared to March 2017 and up modestly from September 2017, which the company attributed to normal seasonal increases in working capital and the impact of the company’s share buyback.The $300 million share repurchase program is expected to be completed before end of calendar 2018. At the end of March, it was about one-third of the way, as the company had spent about $95.4 million to buy back roughly 26.1 million ordinary shares.
The company’s balance sheet is in decent share and key credit metrics are within target ranges. The net debt to EBITDA ratio of 2.2 times was down from 2.4 times a year earlier, while interest cover of 7.5 time was not quite as high as the 7.9 times figure in 1H17, but was still a healthy metric.
Briefly looking at the key business divisions, and Dyno Nobel Americas gained market share and saw a 9% increase in Quarry & Construction sales volumes, 19% increase from Base & Precious Metals customers and a 35% increase in sales volumes to coal customers. Explosives earnings in the Americas business were up 2.7% to US$54.0 million, even as a major work program was undertaken to resolve a problem at the Cheyenne, Wyoming plant.
There was a solid manufacturing performance from Waggaman, with the new plant operating at record levels. Indeed, the 442,000 metric tonnes of ammonia produced represented 110% of nameplate capacity, and up 48% on the prior corresponding period. Earnings increased a modest 4.6% to US$48.0 million though, because the year ago period included construction delay damages that were not repeated in 1H18.
Finally, also in the Americas business and the St Helens plant in Oregon saw some unplanned downtime, leading to a slight US$0.3 million loss in the Agriculture and Industrial Chemicals business. Overall, the Dyno Nobel Americas segment generated EBIT of US$101.7 million, representing a marginal 0.9% year-on-year increase.
The Dyno Nobel Asia Pacific (DNAP) business generated EBIT of $100.1 million, up 9.3% from a year ago. This was driven by solid business in the coal and base & precious metals markets and strong operational performance from Moranbah. The Moranbah plant operated at record levels and produced 189,000 metric tonnes of ammonium nitrate, marking an increase of 36% from a year earlier. On the negative side, after losing some contracts for Roy Hill and BHP in Western Australia the DNAP business incurred some reorganisation costs. Lower sales volumes in Indonesia were also a negative factor. The following chart shows the factors driving the change in EBIT between 1H17 and 1H18.
Dyno Nobel Asia Pacific:
Source: Incitec Pivot (ASX:IPL)
Since the time of the interim results announcement, Incitec has been awarded contracts to supply Fortescue Metals subsidiaries with explosives and services from July 2018 through to December 2023.
This will mitigate some of the adverse impact from losing other contracts, which were previously outlined. Incitec (ASX:IPL) said the contract will have a positive impact on NPAT of $6 million in FY19, some $15 million in FY20, $24 million in FY21 and $9 million in FY22.
Finally, EBIT in the fertilisers business declined 11.7% to $23.3 million. The business faced several headwinds including dry weather across eastern Australia, the strengthening of the Australian dollar and unplanned production outages at Gibson Island.
The following chart summarizes the factors and their impact.
Source: Incitec Pivot (ASX:IPL)
Regarding Gibson Island, in June Incitec Pivot announced it had signed agreements to secure interim gas supplies through to 31 December 2019.
As foreshadowed at the time of the interim results, higher gas costs will boost manufacturing costs by approximately $50 million in FY19.
The company is still looking at options for sourcing gas for the facility after FY19.
As previously announced and discussed in our prior coverage of Incitec (ASX:IPL), the company is working with Central Petroleum to develop gas acreage in Queensland. The joint venture has a commitment to spend up to $20 million on drilling and appraisal works expected to be completed in calendar 2019. If sufficient reserves are proven, it is likely the acreage will begin producing gas from 2022 and supply some of Gibson Island’s needs.
Turning to the daily chart, the technical outlook has improved with prices breaching an intermediate downtrend which dates back to late last year. Resistance at $3.63 has been surmounted which could now act as support and a foundation for a push higher.
Regarding the monthly chart, support was respected at the $2.66 region in September 2016 as marked by the horizontal blue line. This key confluent level of support has managed to also offer a firm floor previously in May and October 2014. In-turn, a healthy and progressive recovery in share price has since followed. At present, upward momentum remains intact, and for this reason, the probability swings towards further upside aimed at the 78.6% Fibonacci retracement of $4.03 (red set of retracements). Looking ahead, if prices were to close (on a monthly-basis) above the 78.6% Fibonacci retracement of $4.03, then two additional broader upside targets would then be triggered. The initial target is seen at the 127.2% Fibonacci extension of $4.87, followed by the 161.8% Fibonacci extension of $5.48.
Summary
The statutory 1H18 results were marred by a non-cash write-down of the Dyno Nobel Asia Pacific business. Shares of Incitec Pivot (ASX:IPL) have however staged a recovery in recent weeks, as the company reported a contract win in West Australia that will mitigate the earlier loss of two other contracts. The company also inked a deal for gas supply to the Gibson Island plant that although this will see costs go up, the change was in line with management’s earlier guidance.
Over the past decade, Incitec Pivot (ASX:IPL) has transformed itself from a southern Australian fertiliser company to a global diversified industrial chemicals company. After countering macro headwinds with operational improvement initiatives (i.e. the Business Excellence (BEx) program), and some solid investments (i.e. Waggaman), the company is well positioned to benefit from a further recovery in commodity prices. The Waggaman Louisianna ammonia (WALA) plant delivered above nameplate capacity in 1H18 and should continue to make a solid contribution to the group.
Incitec Pivot (ASX:IPL) is trading on circa 19.1 times forecast FY18 earnings, and is expected to decline to 17.7 times the following year. The projected dividend yield over the same time frame is 2.6%, expanding to 3%. With a robust outlook for the international explosives business we recommend the shares as a buy for Members without exposure.
Disclosure: Incitec Pivot (ASX:IPL) is held in the Fat Prophets Concentrated Australian and Small & Mid-Cap Models.
