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Expansion Boom?

Resource stocks and those that service the resource sector have fallen from favour lately. But good buying opportunities are seldom found in popular sectors. One stock whose outlook certainly hasn’t blown up is explosives and fertiliser manufacturer Incitec Pivot (IPL). The company held its investor day this week and a flick through the presentation provides a few reasons why IPL should be trading closer to $4 than $3.

First and foremost is the Moranbah AN plant which is on track for production in September. The commissioning process has gone well so far, much to the surprise of many in the industry who thought it would be a failure. These plants are tricky things to get right. Particularly so in this case, with the plant being a refurbished, second-hand US import. But if things continue as they are then IPL is set for a bump when it’s adding to cashflow from next month.

The company already has buyers for the AN, who they are currently supplying through imported product. Capturing the manufacturing margin will drive a significant earnings boost for IPL, comfortably in excess of $100m once the plant hits its stride.

At that kind of contribution, building these plants sounds like a good idea.  In the right location, they certainly are. The problem is determining where demand is sufficient to ensure excess supply doesn’t impair the economics of the project. This is a pretty hot topic for investors at present, with a number of possible projects in the pipeline.

IPL has a couple of proposals on the drawing board too. One is at Kooragang Island to supply explosives to the Hunter Valley coal mines. The other is a little further afield in Louisiana.

Competitor Orica is already established in the Hunter. IPL is being nudged towards entering the market there because the miners would prefer to see a bit more competitive tension between the explosives manufacturers. That isn’t necessarily a good thing for IPL though, so management needs to be certain of the economics before embarking on this move. There’s probably some discount on the stock to reflect this. But there’s really little risk of management pulling the trigger on an uneconomic project.

Financial discipline is what the management team are all about and if they can’t secure supply agreements sufficient for a 15% IRR, then it just isn’t going to happen. Indeed, Kooragang Island is probably a long shot. Louisiana on the other hand is much more likely. The project economics are supported by access to cheap US gas (which is used in the production process) and the additional capacity would allow IPL to capture more of the lucrative US market.

 It probably won’t be until next year before we know which way management is going to go on these expansion plans. But with Moranbah on the cusp of completion, the expansion’s already underway and the share price should follow.

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