Orica: Progressing its strategy + positive industry tailwinds

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
02 March 2022, 10:00 AM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • In line with its strategy, Orica (ASX:ORI) has announced the finalisation of the sale of Minova. The sale price of this non-core business was slightly lower than we hoped and it is dilutive to our forecasts. However, we expect that over time, ORI will invest the funds in higher growth and higher margin opportunities.
  • ORI also provided a trading update. Pleasingly, its FY22 outlook comments remain unchanged, subject to market conditions. In our view, industry fundamentals have improved ORI’s pricing power.
  • We continue to think the earnings downgrade cycle that has plagued ORI for the last few years is over and believe that new management can turn around the business to generate more acceptable returns. However, given ORI is trading in line with our price target of (login to view), we maintain a Hold rating.

Sale of Minova completed; focused on the core, higher margin business

The sale of Minova for A$180m to the Aurelius Group (European based investment firm) was completed on 28 February. This price was slightly lower than we hoped at 5.3x FY21A EBITDA of A$33.7m.

We thought ORI may have been able to sell the business for 6-8x. However, the sale price is above the book value of ~A$160m. Net cash proceeds to ORI are A$149m, after allowing for debt and debt-like items. Selling this business will reduce ORI’s overall exposure to the coal industry.

Under its new MD, ORI is focused on four key business verticals being: mining; quarry and construction; digital; and mining chemicals. FY22 outlook remains unchanged; on track for solid growth in the 1H22.

While ORI hasn’t provided any formal earnings guidance, it reiterated that it expects a stronger 1H22 vs the weak pcp, which was impacted by COVID, China’s ban on Australian thermal coal imports, FX and rising freight and input costs. ORI said that it has been able to maintain positive 4Q21 momentum in the 1H22.

ORI has previously said that earnings will be 2H 22 weighted reflecting greater manufacturing plant turnaround activity in the 1H (completed two turnarounds at its Carseland and Yarwun plants). We expect a 42%/58% earnings skew. We forecast 1H22 underlying EBIT of A$220m, implying 42% growth vs pcp.

Volume growth is expected to be in line with global GDP growth (we assume ~4%). We understand that the demand for AN is strong given buoyant commodity markets and tight industry supply. As contracts are renegotiated, ORI is benefiting from higher AN prices which is mitigating rising input costs and pass-through lags.

1H22 trade working capital will be higher than the pcp given security of supply for ORI’s customers remains a priority in a tightening global AN market due to geopolitical issues and supply chain disruptions.

Despite headwinds such as COVID, adverse weather, exposure to Russia, rising input (gas and ammonia), supply chain (freight) and other inflationary cost pressures, we think the tailwinds far outweigh them given stronger than expected AN demand, tight industry supply, rising AN prices and lower FX.

ORI is also benefiting from solid management of the controllables, the benefits of its new refreshed strategy and its leading global market position. Pricing power appears to be returning and customers are willing to pay for security of supply.

ORI’s Latin American and EMEA businesses source AN from Russia. We understand that if supply becomes constrained, ORI could service these regions from its Yarwun plant in Australia (additional freight cost) and from other markets.

Forecast changes – we remove Minova from our forecasts

While the sale will strengthen its balance sheet, initially the transaction will be dilutive to our forecasts. Our FY22/23/24 NPAT forecasts have fallen by 4.1%/6.2%/6.0%. Despite this, we forecast solid earnings growth over the forecast period due to lesser COVID impacts, significant cost out and a more meaningful contribution from ORI’s four strategic growth pillars.

Investment view: Hold rating 

Following the sale of Minova, our valuation has fallen to (login to view). While we remain positive on the turnaround currently underway at ORI and note that industry tailwinds provide it with the best pricing power in recent years, trading on an FY22/23 PE of 21.4x/19.1x (compares to the 5-year average of 18.4x), we think the stock is fairly priced and maintain a Hold recommendation.

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