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Thematic (Sector/Industry)

Australia Chemicals / Thematic (Sector/Industry)

<div class="content-highlight"><p><strong>The number-one and number-two players in explosives globally are overvalued, but offer much that appeals at the right price.</strong></p></div><p><a href="https://www.smartkarma.com/entities/895" target="_blank" data-smartkarma-citation="entities:895:1">Orica Ltd (ORI AU)</a> and <a href="https://www.smartkarma.com/entities/1127" target="_blank" data-smartkarma-citation="entities:1127:1">Incitec Pivot Ltd (IPL AU)</a> are the sole ASX-listed pure nitrogen-based product manufacturers. They are the world's number-one and number-two explosives companies by market share. Given oligopolistic and duopolistic market positions in the United States and Australia, we’d recommend either company at the right price: Orica for pure explosives exposure, and Incitec Pivot with added diversification into fertilisers. We anticipate healthy earnings expansion for both companies from recent lows. However, both Orica and Incitec Pivot are overvalued, with Orica marginally the cheaper on a price/fair value of 1.15 to Incitec Pivot's 1.25. We think the market ignores the potential for a commodity price retreat, including the likely peaking of China's steel consumption and continuing substitution of energy coal for lower-cost shale gas in the United States, to weigh on explosives revenue growth.</p><hr><h2>Key Takeaways</h2><ul><li>Orica's EBITDA growth exceeds Incitec Pivot's. We presume marginally faster five-year cumulative annual EBITDA growth of 8.2% for Orica in contrast to 7.1% for Incitec Pivot. We expect both firms to expand EBITDA margins by increasing volumes and cost-cutting to levels above five- and 10-year historical averages, adding to our confidence that the market is overstating the potential.</li><li>Commodity prices are bound to ease. Current share prices imply aggressive five-year cumulative annual EBITDA growth of 10.2% for Orica and 10.0% for Incitec Pivot. We expect current high commodity prices are at the heart. If we use spot commodity prices instead of our more conservative midcycle forecasts, resultant fair value estimates more closely approximate current share prices for Orica and Incitec Pivot.</li><li>Orica's slightly stronger EPS growth puts it on a higher multiple. We project five-year cumulative annual EPS and DPS growth of 12.7% for Orica and 12.5% for Incitec Pivot. We assume maintenance of 50% payout ratios for each. Our fair value estimates place Orica on a fiscal 2022 P/E of 11.7 and part-franked dividend yield of 4.3%, and Incitec Pivot on a similar fiscal 2022 P/E of 11.7 and part-franked dividend yield of 4.3%, all discounted at WACC. Nominally, P/E and yields improve to be closer to 7.5 and 7.0%.</li><li>We don't ascribe a moat to either Orica or Incitec Pivot. Unfortunately, the natural industry attribute that has resulted in duopolistic and oligopolistic markets and could result in defensible returns, namely efficient scale, has also prompted plants to be built ahead of initial requirement to preclude competitors capturing first-mover advantages and market share. This has led to oversupply and crimped returns.</li></ul><p><em>Analyst: Mark Taylor</em></p>

The number-one and number-two players in explosives globally are overvalued, but offer much that appeals at the right price.Orica Ltd (ORI AU) and Incitec Pivot Ltd (IPL AU) are the sole ASX-listed pure nitrogen-based product manufacturers. They are the world's number-one and number-two explosives companies by market share. Given oligopolistic and duopolistic market positions in the United States and Australia, we’d recommend either company at the right price: Orica for pure explosives exposure, and Incitec Pivot with added diversification into fertilisers. We anticipate healthy earnings expansion for both companies from recent lows. However, both Orica and Incitec Pivot are overvalued, with Orica marginally the cheaper on a price/fair value of 1.15 to Incitec Pivot's 1.25. We think the market ignores the potential for a commodity price retreat, including the likely peaking of China's steel consumption and continuing substitution of energy coal for lower-cost shale gas in the United States, to weigh on explosives revenue growth.Key TakeawaysOrica's EBITDA growth exceeds Incitec Pivot's. We presume marginally faster five-year cumulative annual EBITDA growth of 8.2% for Orica in contrast to 7.1% for Incitec Pivot. We expect both firms to expand EBITDA margins by increasing volumes and cost-cutting to levels above five- and 10-year historical averages, adding to our confidence that the market is overstating the potential.Commodity prices are bound to ease. Current share prices imply aggressive five-year cumulative annual EBITDA growth of 10.2% for Orica and 10.0% for Incitec Pivot. We expect current high commodity prices are at the heart. If we use spot commodity prices instead of our more conservative midcycle forecasts, resultant fair value estimates more closely approximate current share prices for Orica and Incitec Pivot.Orica's slightly stronger EPS growth puts it on a higher multiple. We project five-year cumulative annual EPS and DPS growth of 12.7% for Orica and 12.5% for Incitec Pivot. We assume maintenance of 50% payout ratios for each. Our fair value estimates place Orica on a fiscal 2022 P/E of 11.7 and part-franked dividend yield of 4.3%, and Incitec Pivot on a similar fiscal 2022 P/E of 11.7 and part-franked dividend yield of 4.3%, all discounted at WACC. Nominally, P/E and yields improve to be closer to 7.5 and 7.0%.We don't ascribe a moat to either Orica or Incitec Pivot. Unfortunately, the natural industry attribute that has resulted in duopolistic and oligopolistic markets and could result in defensible returns, namely efficient scale, has also prompted plants to be built ahead of initial requirement to preclude competitors capturing first-mover advantages and market share. This has led to oversupply and crimped returns.Analyst: Mark Taylor

Market Underplays Commodity Price Risk in Orica and Incitec Pivot