Orica: Can only get better from here

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
30 September 2021, 8:30 AM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • Ahead of its FY21 result on 11 November, Orica (ASX:ORI) has announced A$345-370m of after tax one-off items which will now see it produce a statutory loss. Despite the write-downs, the balance sheet is strong following A$140m of non-core land sales and strong cashflow conversion.
  • The new SaaS accounting standard will increase underlying EBIT in FY21 by A$20m (equates to a 5.0% upgrade).
  • With operating conditions now improving, new management has a refreshed strategy to drive profitable growth in the future and trading on an undemanding FY22 EV/EBITDA multiple of 6.8x, we upgrade to an Add rating.

Event: announcement of one-off items, SaaS impact and FY21 trading update  

ORI has announced that its FY21 reported result will be impacted by A$342-367m after tax one-off items including a goodwill impairment of A$145-155m to EMEA and A$260-270m to Burrup and A$10-15m of restructuring costs. These items will be partially offset by A$70m gain on the sale of non-core land.

The new SaaS accounting standard means that costs relating to cloud computing can no longer be capitalised and will instead be expensed. Given the changes are retrospective, ORI’s FY20A result will need to be restated.

This will impact FY20A reported NPAT given it will be treated as a one-off item (A$85-95m after tax). SaaS will reduce FY21 D&A by A$40m, however operating expenses will rise by A$20m (net underlying EBIT benefit of A$20m in FY21).

ORI’s trading update was in line with previous guidance. Business performance has improved in the 2H21 with AN volumes higher than the 1H21. Specifically, management said that the solid 4Q21 bodes well for the start of FY22.

Analysis

The potential impairment of goodwill for both EMEA and Latin America was flagged at its 1H21 result. Impairment testing has since concluded that Latin America doesn’t need to be impaired however EMEA does given challenging conditions.

ORI has also impaired all the remaining goodwill of its 50% shareholding in Burrup given it is a low returning plant until contracts are renewed in 2025.

New management are focused on reducing ORI’s cost base and another A$10- 15m (after tax impact) of redundancies will be booked in the 2H21. This follows A$15.7m in the 1H21. ORI intends to quantify the expected cost savings across both its manufacturing and corporate functions at the FY21 result.

This will be part of the presentation on the company’s refreshed strategy. It is designed to improve the core business and deliver profitable growth in the future.

Pleasingly, ORI has sold its non-core industrial properties for a good price (A$70m after tax gain), with cash proceeds of A$140m in FY21. These proceeds, along with strong cashflow will strengthen its balance sheet.

Despite the write-downs, FY21 gearing (ND/ND+E) is within its target range of 30-40%. Over FY23/24, ORI will receive another A$150m from land sales. ORI also hopes to announce the sale of Minova in November or possibly earlier (could receive >A$200m).

Forecasts: we upgrade for SaaS accounting 

Reflecting the new SaaS accounting standard, we have increased our FY21/22/23 underlying EBIT forecasts by 5.0%/2.9%/1.7%. The upgrades at the NPAT level are slightly higher than this.

We forecast solid earnings growth from FY22 onwards due to lesser COVID impacts, significant cost out and a more meaningful contribution from ORI’s four strategic growth pillars.

Investment view - upgrade to an ADD rating

We think the earnings downgrade cycle which have plagued ORI for the last few years is now finally over.

While ORI still faces both structural and cyclical headwinds, we think the new management team will turnaround the operations to generate more acceptable returns.

Trading on an FY22 EV/EBITDA multiple of only 6.8x, we think that ORI is undervalued and upgrade to an Add rating (login to view target price).

Price Catalysts – FY21 result on 11 November

We expect the result will beat consensus. We think strong operating cashflow will be the highlight.

We also think the presentation of new management’s refreshed strategy will be well received.

Further non-core asset sales and redeploying the funds to higher returning growth projects is also a catalyst.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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