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Incitec Pivot

ASX :

IPL

Market Cap : $6.89 Billion

52 Week Range : $2.23 - $4.17

Share Price : $3.60

Dividend Per Share : $0.183

Dividend Yield : 5.10 %

Buy

Incitec Pivot's business is resistent to inflation as they enjoy pricing power and dominate the competitive landscape. We recommend a 'Buy'

Company Analysis

Incitec Pivot (ASX: IPL) is a leading supplier in the resources and agricultural sectors. We have recommended IPL earlier, back in 2021 and as good long-term stock to Buy and Hold. Since the recommendation at $2.47 a share, IPL has delivered over 45% returns.

Here’s a brief refresher before heading into the details of its performance and building our investment case. IPL manufactures, markets and distributes a range of industrial chemicals, explosives and fertilisers. It is Australia’s largest fertiliser supplier and the world’s second-largest explosives supplier. As of FY22, IPL operates through three business units:

  • Dyno Nobel Americas;
  • Dyno Nobel Asia Pacific; and
  • Fertilisers Asia Pacific.

Dyno Nobel is the second-largest industrial explosives distributor in North America by volume. It provides ammonium nitrate, initiating systems and services to the Quarry & Construction sector across the US, the Base & Precious Metals sector in the US mid-West, US West and Canada, and the Coal sector in the Powder River Basin, Illinois Basin and Appalachia.

Through Dyno Nobel Asia Pacific, IPL provides ammonium nitrate-based industrial explosives, initiating systems and services to the Metallurgical Coal and Base & Precious Metals sectors in Australia and internationally to several countries, including Indonesia, Papua New Guinea and Turkey through its subsidiaries and joint ventures.

Dyno Nobel is the second-largest industrial explosives distributor in Australia by volume, the world’s third-largest industrial explosives market. In Australia, Dyno Nobel primarily supplies its products to metallurgical coal mines in the east and iron ore mines in the west.

IPL’s Fertilisers business in Australia is the largest domestic manufacturer and supplier of fertilisers by volume. Internationally, the Fertilisers business sells to major offshore agricultural markets in the Asia Pacific, the Indian subcontinent, Brazil and the United States. It also procures fertilisers from overseas manufacturers to meet domestic seasonal peaks. Much of this activity is conducted through Quantum Fertilisers Limited, a Hong Kong-based subsidiary.

Recently, there has been a boom in the mining and agricultural sectors, and favourable macroeconomic factors have carried the IPL share price. Commodity production is hitting record highs across several sectors. While the world is increasing its shift to renewable sources, Coal plants worldwide and especially here in Australia are running at capacity to keep up with the demand. This has resulted in IPL’s explosives division performing robustly.

Inflation has increased the price of agricultural products (food) globally. It’s a necessary industry that will always run at capacity. Given the critical nature of fertilisers and IPL’s dominant competitive position, the firm can pass on any added cost to its customers – thereby protecting its margins even during high inflationary periods.

Company Updates

Titanobel Acquisition boosts firepower

In 2022, IPL announced that it would be acquiring 100% of Titanobel Group, a leading industrial explosives manufacturer and drilling, blasting and technical services provider based in France and across Europe and parts of Western and Southern Africa, Asia and the Pacific region.

  • The purchase price of €91m (~ A$142m2), on a debt-free and cash-free basis, represents an expected acquisition multiple of 7.8x FY20 EBITDA.
  • This investment is expected to be EPS neutral in the first full year of ownership and EPS accretive as synergies are realised.
  • The acquisition will be funded from IPL’s existing cash and debt reserves.

Consistent with IPL’s strategy, this transaction complements Dyno Nobel’s existing operations. It provides access to new markets where Dyno Nobel can leverage its premium technology offering through substitution and growth strategies.


Source: IPL

Titanobel has a strong customer base in the mature and stable European market with exposure to the quarry and construction sector, the growing African hard rock sector and the rapidly expanding mining of future-facing minerals in the EMEA region. The company is supported by a well-established manufacturing base in France, which will be key to delivering the Dyno Nobel strategy in the region.

Titanobel can trace its history back to 1691 and has been a cornerstone of the French explosives industry. With two main business units, explosives and drilling and blasting services, Titanobel have a diversified customer base in more than 30 countries.

Following the acquisition, IPL intends to leverage the existing manufacturing footprint, the skills and technical experience of Titanobel’s existing workforce, and to enhance their offering through the introduction of IPL’s market-leading technologies. Over time, IPL’s value-adding technologies will be expanded into other markets in the EMEA region from this newly enhanced base.

The EMEA market is significant in size, characterised by low ammonium nitrate requirements, stable or growing minerals markets, and large initiating systems with low penetration of electronic detonators.

The acquisition was completed on the 29th of April and will be integrated into IPL. As mentioned earlier, the integration will begin to make its way into IPL’s earnings per share from the 2nd year onwards.

WaggAman Ammonia Plant operations restored

In February, IPL announced a rupture that occurred in a section of the pipe resulting in a release of hydrogen. The root cause analysis indicates that the damage mechanism is limited to this section of pipe. Extensive investigations have revealed only minor damage to surrounding equipment, and repair work is primarily focused on the damaged spool piece.

Proposal to split Fertiliser business from IPL

Just this week, IPL announced its half-year results for FY22 and also threw in a surprise that it intends to implement a structural separation of its Incitec Pivot Fertilisers and Dyno Nobel businesses to create two separately listed companies on the ASX.


Source: IPL

The proposed separation will establish two businesses set up for success in two essential industries:

Dyno Nobel: Global leader in technical explosives solutions, with solid margins and advantaged industry exposures. Dyno Nobel features strong customer relationships and partnerships and an attractive technology backed growth outlook.

Incitec Pivot Fertilisers: Leading fertiliser and soil health company with an extensive and vertically integrated network supporting the East Coast market, a globally strategic food bowl. Incitec Pivot Fertilisers is positioned to capitalise on leading a step-change in sustainable fertiliser and precision agriculture and developing partnerships for world-class fertiliser sourcing, including the potential Perdaman arrangement.

The rationale to separate and extend IPL’s category leadership includes:

  • Both businesses have significant growth potential by accelerating IPL’s core technology offering to two different essential industries.
  • Declining synergy in sharing an ammonia manufacturing core as IPL’s explosives and fertiliser customers require specialised and differing solutions.
  • To extend IPL’s leadership, each business must dedicate its capacity, resources and focus to developing technology to underpin different customer requirements.
  • Megatrends driving demand and specialisation of IPL’s products are expected to intensify, and separation will help best position shareholders to capture significant value.
  • IPL’s current balance sheet is strong and has ample capacity to position both businesses for success.

IPL expects these benefits to accelerate technology-driven growth by unlocking significant improvements to the customer’s experience. Enhanced yields, safety, sustainability and infield service will drive customer retention and growth. The firm said that its businesses would continue to grow with its customers. Its shareholders will benefit from improved margins from value-add technology, earnings resilience, reduced volatility, and improved returns through the cycle.

After completing the proposed separation, IPL expects both Dyno Nobel and Incitec Pivot Fertilisers to have strong balance sheets to support strategic investment opportunities. Dyno Nobel is expected to retain all bank facilities and bonds outstanding at separation and anticipates continuing an investment-grade credit rating. Incitec Pivot Fertilisers is expected to target a conservative leverage profile and a strong balance sheet from the date of separation.


Source: IPL

Next Steps

The proposed separation of Incitec Pivot Fertilisers and Dyno Nobel is expected to be implemented via a court-approved scheme of the arrangement, subject to relevant approvals. Under the proposal:

  • IPL will become Dyno Nobel Limited.
  • The Incitec Pivot Fertilisers business will be demerged under a standalone entity, Incitec Pivot Fertilisers Limited, which will seek listing on ASX.
  • If the separation by way of the demerger is approved and implemented, IPL shareholders will receive shares in Incitec Pivot Fertilisers Limited in proportion to their existing shareholding in IPL and will also retain their existing IPL shares, which will be rebranded Dyno Nobel Limited.

Preparatory separation and cost analysis have been conducted, with the transaction moving into the execution phase. Based on preliminary estimates and analysis undertaken to date, one-off costs are expected to be $80 million – $105 million, and ongoing costs are expected to be approximately $25 million – $35 million per annum.

IPL targeting completion of the proposed separation of the two businesses in the first half of 2023, subject to required approvals and consent. IPL is expected to announce more details of the separation at its Investor Day 2022 conference (usually held at the end of July).

Investment Thesis

IPL announced a record first-half performance capturing a commodity upswing. We saw strong growth in IPL’s technology and good momentum on explosives and fertilisers strategy. Incitec Pivot announced:

  • NPAT of A$384m, up A$348m from A$36m on pcp.
  • Earnings Before Interest and Tax (EBIT): A$568m, up A$458m from A$110m on pcp.
  • Earnings Per Share: 19.8 cents per share, up 17.9 cents per share from 1.9 cents per share on pcp.
  • A strengthened balance sheet with net debt of $1.4bn and a Net Debt/ EBITDA ratio of 1.0x, down from 2.1x on pcp.
  • Return on invested capital (ROIC) improved during the year to 10.1%, up from 3.2% on pcp.
  • Interim dividend of 10 cents per share declared, fully franked.

Higher commodity prices contributed $445m to the result compared to pcp, with a slightly weaker Australian dollar contributing a further $27m.

Dyno Nobel Americas

Dyno Nobel Americas (DNA) reported EBIT of US$182m (A$252m), up to US$159m (A$220m) on pcp, supported by improved volumes and technology-driven margin improvements. DNA explosives sales improved across all sectors:

  • Quarry and Construction volumes increased 9% on pcp with strong infrastructure spending
  • Base and Precious Metals volumes increased 2% on pcp, with gold and copper production driving growth
  • Coal volumes increased 17% on pcp with increased demand from the Powder River Basin

There was continued technology growth with Electronic Detonator sales and further Delta-E uptake. Waggaman plant production and efficiency were strong through to the unexpected outage in mid-February, with the plant continuing to perform well since the restart in April.


Source: IPL

The higher results were a direct result of:

Market Growth: US$4m increase from pcp. Volumes increased yearly across all sectors, with Q&C up 9%, Metals up 2% and coal increasing by 17%, with the resurgence in coal-driven by higher gas costs. Margins in the Explosives business increased to 11.8%, up from 10.8% in 1H21.

Supply Chain / CPI: US$3m cost increase compared to pcp. Supply chain disruptions have increased lead times and resulted in higher costs. Inflation has impacted the costs base, but most significantly in labour costs. To date, the business has been managing these increases through contract negotiations. Despite these pressures being expected to continue in the second half, re-pricing and other efficiency improvements are expected to offset these cost increases.

Manufacturing: Improved reliability at Dyno Nobel America’s two ammonium nitrate manufacturing facilities has resulted in a US$8m benefit compared to pcp.

Quarry & Construction: 40% of Explosives revenue was generated from the Quarry & Construction sector in 1H22 (38% pcp). Volumes grew 9% in this sector, and high single-digit growth is expected to continue through the remainder of the year. US infrastructure spending is expected to keep non-building construction levels elevated into FY23.

Base & Precious Metals: 39% of Explosives revenue was generated from the Base & Precious Metals sector in 1H22 (41% pcp). Volumes grew by 2% during the year. The primary driver of this increase was sales into the metals markets in Canada. Metals markets are expected to be mixed in the second half, with overall growth in the low single digits.

Coal: 22% of Explosives revenue was generated from the Coal sector in 1H22 (20% pcp). Volumes were up 17% versus the pcp with high natural gas prices, improving coal’s competitiveness as an energy source. Coal production is expected to remain elevated through the second half, although the longer-term structural decline of this market is still expected.

Dyno Nobel Asia Pacific

Dyno Nobel Asia Pacific delivered EBIT of A$79m, up 13% (A$9m) on pcp, improved by solid growth in volumes across all markets, technology, and recovery in the international business. Strong momentum in technology continued with revenue growth and margin expansion with Electronic Detonators sales up 20% and premium emulsions up 16%, on pcp. The end of WA contract losses (as previously disclosed in 2018) accounted for a $4m earnings improvement on pcp. A $2m net increase in customer growth was driven by customer growth in gold and precious metals and improvements in value in use and product mix.

Australian Metallurgical Coal: 46% of Dyno Nobel Asia Pacific revenue for the year was generated from the Australian Coal sector, which was from supply to Metallurgical coal mines in the Bowen Basin. Volumes from the Metallurgical Coal sector were up 3% on the pcp, with tight global seaborne metallurgical coal supply providing supportive conditions for Australian miners.

Base & Precious Metals: 42% of Dyno Nobel Asia Pacific revenue was generated from the Base & Precious Metals sector, which comprises iron ore mines in Western Australia and hard rock and underground mines throughout Australia. Volumes from the sector were down marginally (less than one percent), while revenues were up 18% compared with the pcp. Higher technology sales and enhanced product mix improved sales in this sector.

International: 12% of Dyno Nobel Asia Pacific revenue was generated internationally in Indonesia, Turkey and Papua New Guinea, increasing 52% on the pcp. Volumes increased by 37% compared to the pcp as mines shut down due to COVID restrictions in FY20 and FY21 returned to production.

Fertilisers Asia Pacific

Fertilisers Asia Pacific earnings of $257m were $237m higher than the pcp and a record first half result for the business. Major movements for the year were due to the following:

Manufacturing: Net $5m reduction in depreciation charges due to the impairment of Gibson Island assets in September 2021 ($10m) offset by higher depreciation at Phosphate Hill mainly related to capital expenditure for the construction of critical infrastructure ($5m).

Volumes and Margins: Despite a slight reduction in domestic volumes sold compared to the pcp (down 2.6%), Distribution earnings were up marginally due to a favourable product mix. Volumes were impacted by a delay in applications due to heavy rains in NSW and Southern Queensland and higher prices delaying some farmer demand.

Distribution margins (earnings/revenue) declined by 1.7% as a result of elevated prices in 1H22. Earnings per tonne of product sold improved due to the favourable product mix achieved in the first half.

Unsold Manufactured Product: The increase in the value of unsold manufacturing products from 1H21 to 1H22 was a function of higher ammonium phosphate prices.

Foreign Exchange and Commodity Prices: $253m net increase, primarily driven by higher DAP price ($821/t vs $426/t), higher Urea price ($767/t vs $296/t) and lower AUD/USD exchange rate (0.72 vs 0.75) partially offset by higher cost sulphur/sulphuric acid.


Source: IPL

Total Fertilisers Asia Pacific sales volumes of 1,098k metric tonnes were 13% lower than pcp sales of 1,257k metric tonnes. This reduction is mainly due to applications into the winter season being delayed due to recent floods in NSW and Southern Queensland and customer buying habits.

Sales of premium products have continued to grow, with liquid fertiliser sales up 25% on pcp. Global fertiliser prices continued to trend higher in 1H22 following strong gains in FY21. Realised Ammonium Phosphate prices improved by 93% compared with the pcp, while, despite its volatility, realised Urea prices increased 159% over the pcp. The supply and demand dynamic remains broadly favourable to support high prices in the near term.

Progress on the soil health strategy continues, highlighted by the performance of the Nutrient Advantage laboratory, which showed an increase of 13% in the number of lab tests conducted compared with the pcp. The Australian Bio Fert joint venture is progressing to plan with key management positions in place and planning for the construction of the initial commercial production facility well underway.

Outlook

IPL has been successful in managing non-commodity related inflationary pressures. Inflation is increasingly impacting the firm’s cost base, with rising people and other input costs. Where possible, these costs are managed by re-pricing through to IPL’s customers and efficiency measures. This is the pricing power property, making IPL a good investment during inflationary periods.

Global supply chains have been significantly disrupted since the COVID pandemic began, and it is expected that this disruption will continue in the second half. Allowance for longer lead times, identifying alternative sourcing, and increased strategic buffer stocks have helped mitigate any adverse impacts.

Dyno Nobel Americas

The Waggaman plant is expected to produce at nameplate capacity in 2H22. The operational earnings of Waggaman remain subject to movements in ammonia and natural gas prices. Our current plan is to install the new replacement cooler in FY23 while the new boiler is installed. The timing in FY23 will be determined by plant performance and market conditions.

Agriculture & Industrial Chemicals earnings remain subject to movements in global fertilisers prices, particularly Urea.

Coal production rose 6% in the first half, with Powder River Basin up approximately 10% in 1H22. Elevated natural gas prices point to coal production remaining elevated to meet customer demand in the near term.

The Quarry and Construction market grew 9% in 1H22, and that growth is expected to continue into 2H22. Infrastructure spending is expected to keep non-residential construction elevated into FY23.

Elevated commodity prices should support the Base and Precious Metals sector demand, with low single-digit growth expected in 2H22.

Dyno Nobel Asia Pacific

Moranbah is expected to operate at nameplate capacity during 2H22. The customer and technology growth achieved in the first half is expected to continue in 2H22. Recovery in earnings from international businesses is expected to continue but remains subject to customer demand within the offshore markets. In line with previous disclosure, the unfavourable Western Australian supply arrangements cease in FY22 resulting in a boost to earnings (compared to FY21) of approximately $11m on a full-year basis.

Fertilisers Asia Pacific

Fertiliser’s earnings will continue to be dependent on global fertiliser prices, the A$:US$ exchange rate and weather conditions. Despite the severe flooding in NSW and southern Queensland, agricultural conditions across Eastern Australia are generally favourable. Increased soil moisture levels in most districts on the East Coast, coupled with high dam levels, are expected to drive demand for fertiliser throughout the year.

Farm economics are expected to remain favourable through FY22, with farmer cashflows supportive of strong fertiliser demand, although high fertiliser prices can influence volumes. Distribution margins and volumes are expected to remain subject to Australian East Coast agronomic conditions and global fertiliser prices. IPL is actively managing the business to mitigate these risks with volatile global fertiliser prices and long supply chains increasing price risk.

Dividends Increased 10x

Incitec Pivot is not just all about growth. The dividends have increased considerably over time. The boosted cash flows have resulted in IPL’s interim dividend going from 1 cent in 2021 to 10 cents in 1H22. This represented 51% of IPL’s Net Profit. Currently, IPL shares are trading with a yield of over 5%, fully franked. The elevated business performance should continue and therefore, the dividends should continue to grow.

Our earlier report can be accessed by clicking here.

Recommendation

Incitec Pivot has delivered a fantastic result amid a robust operating environment. Mining in Australia and globally remains elevated as there is a supply crunch across several commodities. This has resulted in IPL’s explosives business booming. Fertiliser demand is at healthy levels, and it is forecasted to continue to be at these levels. The separation of the fertiliser assets from the explosives assets has been announced and it will create two independent entities in 2023 if the proposal goes through. IPL’s businesses have protection from inflation due to their pricing power and the necessity of their products in the mining and agriculture industries. We continue to recommend investors to “Buy“.

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