Orica: Result 2013

With Orica’s share price up about 20% since Monday's full-year result, you might have thought profits were soaring and the outlook brightening. The numbers tell a different tale. Earnings before interest and tax (EBIT) fell 4% to $985m and, although statutory profits rose 49% to $600m, that reflected last year’s write-offs more than this year’s improvement. On an underlying basis, net profit fell 7%.

From earnings per share of 165 cents, down 7%, an interim dividend of 55 cents was declared (ex date 19 Nov), taking full-year dividends to 94 cents – 2% more than last year and giving the stock a yield of 4%.

The big improvement was from operating cash flow, which rose 95% to $1bn, easing concerns raised by last year’s dismal cash flow performance. This was important because net debt climbed slightly higher to $2.3bn. Strong operating cash flow, enough to cover interest payments 7 times, suggests there are no imminent problems with debt.

The result may have been a surprise to the market but it was no surprise to us. As the dominant supplier of explosives, Orica is a high-quality business. Even during a softening investment cycle, operating margins remained steady and returns on capital remained high. The company, however, isn’t without warts.

Sales volume from North America declined more than 5% as the US coal market, a big user of explosives, enters structural decline. This is likely to persist, although growth from elsewhere in the business has offset the decline to date.

Of more concern is the continuing poor performance of the former Minova division, which makes steel supports for underground mining. With another year of poor performance, pressure for additional write-offs or a full sale of the division – at a huge loss – is rising.

Orica did correct one potential problem, announcing a new gas supply contract with BHP/Esso. The company will source 14 petajoules (PJ) of gas a year to fuel its operations. We expect gas prices along Australia’s east coast to rise exponentially in the years ahead so securing supply now is vital. The contract is reportedly linked to oil prices so Orica’s costs will rise but it should be able to pass these onto its customers.

Orica briefly fell below our buy price earlier this year but, with price back to where it was at 17 May 13 (Hold – $23.43), it is not quite cheap enough to buy yet. HOLD.