MARKETS SPECTATOR: Orica cops an outburst

Margin squeeze in explosives and doubts about its Minova equipment division have prompted UBS to downgrade Orica.

Orica (ORI) has been downgraded to neutral from buy this morning by UBS, with a 12-month price target of $27.80 per share.

Following an in-depth review of the Australasian explosives manufacturer's earnings drivers, which represent about 40 per cent of the group’s EBIT, the broker remains positive about the outlook for domestic explosives volume growth but is cautious on margins following a five-year period of strong growth.

Its view is predicated on less favourable demand supply fundamentals and, when combined with increasing pressure from its customers, it suggests domestic margins are peaking which will limit the scope for further upside earnings surprises.

Following yesterday’s full year 2013 earnings outlook comments, UBS has cut its forecasts by 2 per cent in full year 2013 and 1 per cent in full year 2014 to reflect yesterday’s report.

“The stock looks cheap but is lacking catalysts," the broker wrote in a note to clients. "Orica is down 6 per cent in the last week, versus a 2 per cent drop in the Australian market, and Incitec flat week on week."

"This sees the stock on 12-times our full year 2014 estimates earnings per share, which appears cheap relative to the Australian Industrials ex-fins, although we believe Orica is lacking catalysts with continued uncertainty around the following impacting sentiment: 1) Longer term Australian explosives margin uncertainty given the tougher volume outlook, increasing capacity and lower commodity prices; 2) Less visibility around the Minova project turnaround, with UBSe forecasts well below management’s five-year guidance outlook.”