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 MARKET REPORTS |
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Analyst report - shares
Stock of the week – Incitec Pivot
January 30, 2008
Tim Morris, wise-owl.com analyst
Stock: Incitec Pivot
Recommendation: BUY
Code: IPL
Market Cap: $5.6bn
Incitec’s (IPL) marvelous job of transforming dung into dollars has seen its share price become a stand out performer in the ASX200, rising from levels around $20 in 2006 to recent highs in excess of $120.
This fertilizer manufacturer’s remarkable run over the last year or so has been driven by its ability to grow earnings in the face of a challenging domestic operating environment characterised by the drought. As farmers are the main users of fertilizers, it almost seemed a natural course for the drought induced reduction in crop sizes along the east coast to reduce demand for fertilizer, and hence affect IPL’s earnings.
However, an active cost cutting and efficiency drive from management ensured that Incitec defied these forces and surprised the market. With the company having endured what many believe to be the bottom of the agricultural cycle, it is now poised for growth, providing investors a balanced and diversified exposure to the rural sector.
IPL is Australia’s largest fertilizer manufacturer, controlling around 80%, or 2.5million tonnes of our nation’s manufacturing capacity. IPL’s operations extend down the fertilizer value chain, as the company also distributes its product to key rural retailers who then on-sell to farmers. A minority of sales are made directly to farmers from its wholesale operations.
The company’s six manufacturing plants are located across Queensland, New South Wales and Victoria. Currently manufacturing is the most critical part of IPL’s operations, forming 81% of last years EBIT. Incitec’s distribution network stretches from Darwin in the Northern Territory to Brighton in southern Tasmania. Incitec’s product range includes urea, ammonium phosphates, superphosphate and anhydrous ammonia, which can be applied to crops as solids in granulated form, as liquid nutrients, or as gas injected into the soil.
The successful efficiency drive which has helped alleviate the impact of the drought has been flagged ‘project Tardis’. Although one off restructuring costs in the vicinity of $57m before tax were incurred, the project has generated an EBIT benefit of $104 million plus a $155.5 million reduction in working capital.
These savings, which have thus far been more than double initial forecasts, are not small change when you consider that Incitec’s EBIT was under $100m when the Tardis program was implemented in 2005. EBIT for the most recent financial year amounted to over $300m, an increase of 148% over the prior period. Normalised net profit after tax rose by a similar amount to just over $200m.
According to the company, overall earnings would have halved had these initiatives within existing operations not been undertaken. While the cost savings maintained earnings in the face of the drought, the driver of growth has been 2006 acquisition of Southern Cross Fertilizer’s from BHP. Costing $165m, the unit generated over $200m EBIT in FY2007, or around two thirds of Incitec’s overall earnings. Southern Cross has witnessed remarkable earnings growth thanks, in part to $40m in cost synergies as a part of the Tardis program, but mostly due to rises in DiAmmonium Phosphate (DAP) prices.
In addition to bolstering IPL’s position in the domestic market, the Southern Cross acquisition opened up export opportunities. This was an important development because strong international markets for fertilizer have helped offset lower domestic demand.
The global demand picture for fertilizers is robust. Fertilizer consumption has grown at an average of 4% over the last 20 years. The world population is growing rapidly, and the amount of arable land per capita has been falling for the last 50 years. Rising incomes in the developing world is triggering a quality shift in dietary patterns towards meat products. The grain intensive nature of meat production puts further pressure on farming land. Fertilizers provide a solution to this problem by increasing crop yields, which is why their global demand outlook is favourable.
Closer to home, recent rains across northern NSW and QLD have brought hopes that the drought is fading in these regions. An improvement in domestic fertilizer demand could therefore be a bonus for the company in the year ahead as it enjoys further efficiency gains from project ‘Tardis’, and continuing strength in fertilizer prices.
The stock’s recent pull back in the midst of the broader market panic provides an attractive buying opportunity. Trading on a forward PE of just over 16, the stock may not be a screaming bargain, but it does offer one of the better value plays within the agricultural sector, where sentiment is showing no signs of remorse.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
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Stocks: Stock of the week- Incitec
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Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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