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Explosive Issue

Although the broader Aussie stock market has put in a strong performance this year, that doesn’t mean that all stocks are now expensive. Some have in fact significantly underperformed the index. Particularly anything mining services related. The cost pushback from the big miners is well known and has caused more than a few downgrades in the sector. But the actual impact to earnings isn’t always commensurate with the stock’s price action.

A good example is Orica. The market has been concerned about the extent to which the miners will squeeze Orica’s explosives’ margins for some time. The company did also downgrade in July and the pre-GFC Minova/Excel acquisitions are clearly not going well. But the core business of ammonium nitrate production and sales is still looking pretty good.

Orica presented at a broker conference in Hong Kong recently and those looking for evidence of a significant deterioration in explosives volumes and pricing were disappointed.

Management revealed that 2013 global contract renewals have been struck at flat prices on average and that 90% of contract renewals have been retained. Furthermore, of the 10% that have not, $2 of revenue has been pulled in to replace each $1 lost. Meanwhile, volumes are down 2% globally, but that reflects weakness in the Americas and Asia, not the all-important east coast Australian coal market where production levels remain high.

The other issue that is a bit of a problem for Orica is that the market doesn’t really view CEO Ian Smith in a positive light. This may be partly due to his acquisition of Lihir Gold while head of Newcrest, but is also probably because Ian isn’t the type of CEO that actively courts investor affection. It certainly isn’t due to his operating ability. Indeed, his strategy of pushing Orica up the value chain from being a commodity supplier to a high-end blasting services company is sound.

All-in-all, we think the market’s got it wrong on Orica and getting in at around $20, on an FY14 PE of 11x and a 4.4% yield is likely to serve longer term investors well. After all, blowing things up never goes out of fashion!

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