Hot Stock

Hot Stock

Sydney Morning Herald

Wednesday November 5, 2008

Greg Canavan. Greg Canavan is head of Australasian research at Fat Prophets.

What's new? Like most commodity-related companies, Incitec Pivot has been harshly dealt with by investors in recent months. The acquisition of explosives manufacturer Dyno Nobel in March, at bull-market multiples, hasn't done the share price any favours either.

Incitec Pivot is a chemical manufacturer supplying agricultural fertilisers and industrial chemicals in Australia and globally. The company operates a phosphate mine in Queensland, supplying raw material to its own manufacturing plants located along the east coast of Australia. These plants produce agricultural fertilisers such as urea, ammonium phosphates and superphosphate. Incitec Pivot supplies more than 50 per cent of Australia's agricultural nutrient needs.

The acquisition of Dyno Nobel provides Incitec Pivot with a predominantly North American commercial explosives exposure, including a manufacturing and distribution network.

The enlarged company now has exposure to both "soft" and "hard" commodities, which until three months ago was an extremely compelling story.

The outlook That story is still compelling, depending on your time horizon. Shorter term, the outlook is uncertain. Agricultural fertiliser product prices are set globally and after rising strongly over the past few years, these prices have begun to pull back and could retreat further in line with other commodity markets.

On the explosives side of the business, reduced mining exploration and expansion budgets may crimp short-term demand for the company's products.

The investment case for agricultural fertiliser products in recent years has been the rather enlightening concept that "people need to eat". More specifically, the argument is that emerging nations with rising wealth will demand higher-protein diets. More protein means more grain is required to feed livestock. Existing farmland will therefore need to be worked harder, with the help of fertiliser, to yield more.

Price This bullish theme caught on, especially as grain prices surged throughout 2007 and into 2008, as higher prices pointed to more crop plantings and more fertiliser usage. Adjusting for the recent share split, Incitec Pivot's price moved from just over $1 at the end of 2006 to more than $9 in mid 2008. Not surprisingly, the stock has come back to earth and now trades about the $4 mark.

Worth buying? There are many moving parts to Incitec Pivot's valuation, including the underlying prices for agricultural fertiliser products, demand for fertiliser (impacted by weather) as well as the capital expenditure budgets of the global mining industry. So earnings forecasts are open to wide interpretation. Bloomberg consensus estimates place the company on a price-earnings multiple of seven times earnings for the year to September, so one would think much uncertainty is already priced in.

While the stock looks fundamentally cheap, we would prefer to wait for signs that fertiliser product prices are stabilising before buying. Moreover, we would like to gain a clearer picture of how Dyno Nobel is performing, especially given the recent slowdown in the commodities space. The annual results are due shortly so we won't have long to wait.