Company Overview: Incitec Pivot Limited (ASX: IPL) is engaged in the manufacturing and distribution of industrial explosives, industrial chemicals and fertilizers, and the provision of related services. It is a recognized world leader in the resources and agricultural sectors. With 66 manufacturing facilities and joint ventures across five continents, including Australia, North America, Europe, Asia, Latin America and Africa, IPL manufacture ammonium nitrate-based explosives, nitrogen and phosphorus fertilizers, and nitrogen related industrial and specialty chemicals.

IPL Details

Decent Fundamentals and Progress in Strategic Agendas: Incitec Pivot Limited (ASX: IPL) is engaged in the manufacturing and distribution of industrial explosives, industrial chemicals and fertilizers, and the provision of related services. As on 17 August 2020, the market capitalization of the company stood at ~$4.21 billion. The company retains a decent underlying business model and continues to make progress on its purpose of unlocking the world’s natural resources through innovation on the ground. Despite the challenging market conditions, the company reported FY19 EBIT of $303.7 million and net profit after tax of $152.4 million.

It continues to emphasize the importance of its priority right of Zero Harm across its global business and set its goal for a step change to achieve a 30% reduction in Total Recordable Injury Frequency Rate by FY21. The company retains strong fundamentals and has progressed in its strategic agendas. The manufacturing excellence strategy of the business delivered top quartile reliability performance which is likely to uplift $40 million to $50 million of earnings by FY22. Accelerated adoption of electronics and delivery systems by the mining industry resulted in the growth in its premium technology offering and productivity at mine sites.

The company will continue to attract opportunities to reduce its environmental footprint across the business and is looking for the best way for the business to reach its potential. The company is increasing its environmental impacts and has increased operational control of the product and a reduction in environmental risks associated with product tracking and spills across its fertilizer distribution centres.

The company had a clear strategy to improve shareholder value through leveraging strategically located assets, premium technology solutions and manufacturing excellence. However, COVID-19 introduced new risks to recovery in commodity prices and global economic uncertainty impacted customer demand. During 1H20, the company reported resilient mining volumes, continued technology growth, improved manufacturing, and strong cash flow management.

The company retains decent fundamentals and seems to be well-positioned to deliver decent earnings in years to come. It witnessed continued growth in the Quarry & Construction sector and growth in market share through premium technology. It is focusing on leveraging and improving the base business and is aiming value chain optimization and investing in capabilities to create new products and solutions in precision agriculture.  

FY19 Financial Highlights (Source: Company Reports)

Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of Incitec Pivot Limited. Perpetual Investment Management Limited is the largest shareholder in the company, with a percentage holding of 7.99%.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Higher Gross Margin and Increasing Profitability: During 1H20, gross margin of the company stood at 55.6%, higher than the industry median of 43% and net margin of the company witnessed an increase over the previous year and stood at 3.5%, up from 2.4% in 1H19. This shows that the company is well managing its costs and is capable of converting its revenue into profits. During the half year, EBITDA margin of the company stood at 16.2%, up from 13.2% in the previous half, indicating increased profitability. In the same time span, Return on Equity of the company stood at 1.4%, reflecting an increase from 0.9% in 1H19. This indicates that the company is well managing the capital of its shareholders and is capable of generating profits internally. During the 1H20, debt/equity ratio of the company was 0.59x, and assets/equity ratio of the company stood at 2.06x.

Key Margins (Source: Refinitiv, Thomson Reuters)

Half Year Results: During 1H20, the company reported resilient mining volumes, continued technology growth, improved manufacturing, and strong cash flow management. During the half-year, revenue of the company went up by 6% to $1,848 million, and EBIT of the company witnessed an increase of 34% to $159 million. In the same time span, NPAT of the company increased by 54% on 1H19 to $65 million. The company is focused on improving ROIC, underpinned by strategic growth drivers and is aiming for cost efficiency. During 1H20, operating cash flows of the company went up to $152 million from a negative cash flow of $35 million in 1H19. This was mainly due to improved business earnings and ongoing working capital management. In the same time span, the company raised capital and reported a stable balance sheet with Net Debt/EBITDA ratio of 2.8x.

The company actively managed the pandemic related challenges and continued to prioritize updated business continuity plans along with organizing workforce planning and shift changes to reduce the risk of infection. The stable balance sheet is likely to offer resilience in an uncertain environment and financial flexibility to support disciplined organic growth opportunities.

1H20 Financial Highlights (Source: Company Reports)

Competitive Advantage and Decent Margins: The company has the premium technology in the market which is suited for growth markets/sectors. It retains a decent EBIT margin of over 14% reflecting value add premium technology and markets and retains a quality customer base with high-end customers including RioTinto, Glencore, etc. The company is focused on delivering long-term growth underpinned by strategic drivers and cycle improvement.

Key Risks: The group is exposed to a variety of risks, including the risks arising from COVID-19 on its people and operations. The extent of the future impact of COVID-19 is dependent on the duration and spread of the outbreak, regulations imposed by governments with respect to the outbreak response, and the impact of the pandemic on the global economy, including commodity prices and customer demand. The company is also susceptible to the climate change-related financial risks, environmental risks associated with product tracking and spills across its fertilizer distribution centres.

Future Expectations and Growth Opportunities: The company has resilient end markets and is expecting an uplift of $60 million per annum in EBIT, from expected cost savings by FY22. The company seems to be well-poised for margin expansion and is expecting growth in explosives from FY21, backed by technology and track record of execution in growth delivery. IPL has a long runway of technology adoption in existing markets and will have a decent pipeline of manufacturing excellence of $40 million to $50 million per annum by FY22. The company has an unmatched platform to distribute advanced fertilizer products & services and seems to be well-placed for recovery in commodity prices. It is likely to release its full year results for FY20 on 10 November 2020.

IPL is implementing reliability plans across key plants and is expecting YTD TRIFR of 0.56 in June FY20. The company is simplifying its debt structures over the next 18 months and is expected to set up a strong cash generation from FY23. It is targeting higher returns from premium technology offering which is delivering strong ROIC in commercial businesses.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The company is benefitting from favorable fundamentals for long term global fertilizers, improving Australian conditions and high leverage to current low fertilizers prices. IPL is focused on driving cost efficiencies and margin improvement and is leveraging its distribution platform to drive new growth initiatives towards soil health. As per ASX, the stock of IPL gave a return of 11.28% in the past three months and a return of 18.58% in the past one month. The stock is inclined towards its 52-weeks’ low level of $1.565, proffering a decent opportunity for accumulation. We have valued the stock using the EV/Sales multiple based illustrative relative valuation and arrived at a target price of low double-digit upside (in percentage terms). Considering the current trading levels, decent returns in the past three months, resilient financial position, and long-term growth opportunities, we recommend a ‘Buy’ rating on the stock at the current market price of $2.170 on 17 August 2020.

IPL Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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