Orica: Cyclical and structural pressures remain

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
10 September 2021, 9:00 AM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • In a broker presentation, ORI said that the 2H21 has been largely in line with its expectations, with lower FX offsetting rising supply chain (freight) costs. Some of its markets continue to be impacted by COVID and Latin America continues to be affected by unrest and geopolitical issues.
  • We have left our FY21 forecasts largely unchanged but have reduced our FY22 and FY23 forecasts due to cyclical and structural issues impacting the business. Despite this, we expect solid earnings growth from FY22 on lesser COVID impacts, significant cost out, and a more meaningful contribution from ORI’s five strategic growth priorities.
  • While we believe Orica (ASX:ORI) is well positioned over the medium term, given earnings uncertainty remains in the short term, we maintain a Hold rating. However, we believe that shareholders are in a safe pair of hands with new CEO, Sanjeev Gandhi, who has a strong track record.

Event: broker presentation highlights that 2H21 is in line with expectations

In a broker presentation, Orica (ASX:ORI) provided a trading update on its 2H21 performance compared to outlook comments it made at its 1H21 result in May. It highlighted that there had been no material changes in the business. We therefore expect it is comfortable with FY21 consensus estimates.

Analysis: challenges remain in its key markets

ORI said that 2H21 volumes were improving in all markets as expected. This is despite COVID impacting some of its sub-regions (Indonesia, Africa and parts of Latin America), lower exports to China due to the coal tariffs and geopolitical issues in Latin America.

Exsa continues to perform well and all manufacturing plants are operating well with strong utilisation. Burrup is producing to plan, albeit they are lower margin tonnes. The SAP system stabilisation is on track and expected to be completed by the end of FY22.ORI is on track to deliver A$15m of EBIT in FY21 from its new technology. 

Increased supply chain costs (freight costs are up 30% since October 2020) have been affecting earnings particularly in EMEA and Latin America although this has been partially offset by AUD depreciation since the 1H.

At its FY21 result on 11 November, ORI's new management team is expected to deliver a refreshed strategy to drive profitable growth into the future. The focus areas are overhead cost reduction, which is expected to be delivered from FY22, and ongoing balance sheet strength, involving the sale of non-core assets and capital discipline. Given the input cost pressures ORI faces, it needs to reduce its manufacturing costs. It is also focused on lowering corporate costs.

Over the next couple of years, ORI is looking to achieve up to A$300m from the sale of non-core industrial properties.

Additionally, Minova is up for sale (could realise in excess of A$200m). Capex is also being reduced. We understand that there has been strong interest in Minova. Selling this business would reduce ORI's overall exposure to the coal industry.

We revise our FY22 and FY23 forecasts

Following ORI’s update, our FY21 forecasts are largely unchanged. We forecast 2H21 EBIT of A$248m, down 16% on the pcp.

We have revised our FY22 and FY23 forecasts in light of COVID still impacting some of its markets, higher inputs costs (gas, ammonia, freight), China’s ban on Australian thermal coal imports and structural changes in Columbia. Despite these factors, we forecast solid earnings growth from FY22 onwards.

We now assume that ORI exceeds its FY20 earnings in FY24 reflecting an earnings recovery from COVID headwinds, its five strategic growth initiatives and cost out. However, our FY24 forecast is still 6.5% below FY19 level (pre-COVID) given the structural issues impacting the business.

Investment view – Hold 

While we believe that ORI will ultimately prove to be a turnaround story under new management, there is much work to be done to restore its earnings to a more acceptable level. It also faces structural issues (coal, rising gas prices, and issues in emerging markets).

We maintain a Hold rating. Post forecast changes, our blended valuation has fallen to (login to view).

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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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