An ASX heavyweight undervalued for the first time in almost two years

ASX-listed explosives and fertiliser manufacturer Incitec Pivot (IPL) recovered around 3% on Thursday, as some investors chose to swoop in and buy up following an 8% plunge a day earlier.

The company reported an 8% decline in first-half fiscal 2023 underlying net profit after tax to $354 million, marginally ahead of Morningstar's $347 million expectations.

But investors weren't impressed with a 58% slump in its key fertiliser division.

The drop has been attributed to commodity price headwinds after heavy rainfall triggered a drop in demand from farmers, which was further compounded by higher input costs.

The underwhelming result arrives as the company prepares to sell its Waggaman ammonia manufacturing facility in Louisiana and spin-off its Dyno Nobel explosives business. 

Following the news, shares in the company hit an 18-month low and remain more than 25% down on their November 2022 peak. 

Morningstar has maintained its assessed fair value of the company’s shares, which stands at $3.50 per share. As a result, Morningstar has now reclassified Incitec Pivor as a 4-star stock, meaning at their current price, shares are screening as “undervalued” against their assessed fair value. 

This is the first time in almost two years that Morningstar has classified the shares as 4-star, with the stock bouncing between 3-star (“fairly valued”) and 2-star (“overvalued”) ratings since July 2021.

Morningstar: Explosives "save the day"

Morningstar analyst Mark Taylor says a doubling of earnings in the company’s explosives segment helped “save the day” in the half-year results but shouldn’t be expected to help in future.  

“A very strong first-half fiscal 2023 margin performance from Dyno Nobel Americas made up for softer-than-expected margins across other businesses,” he says.

“However, the increase was solely down to WALA ammonia earnings doubling, and as we know Incitec has agreed to sell WALA, so there is no longer-term ongoing implication.”

While the market was not impressed with the outcome, Taylor says, Incitec is now screening attractive from a price-point perspective, noting a more favourable outlook for the company’s key segments expected in the next half.

“The drivers are favourable Dyno Nobel Americas sales mix and growing customer base, with benefits from price resets progressively benefitting from March 2023 and cost reduction initiatives in evidence,” he says.

“The extreme first-half winter conditions and record snowfall in the U.S. thankfully won't feature in the fiscal second half. And favourable eastern Australian agricultural conditions are also anticipated,“ Taylor adds.

Consequently, Morningstar now forecasts around 55% of the company’s full-year earnings to be captured in the fiscal second half, which may offset some of the disappointment felt this week—as might the ten-cent interim dividend dished out to shareholders.

Factoring in the slightly-higher-than-expected dividend, Morningstar has increased its fiscal 2023 dividend forecast to 21 cents per share.  

“It equates to a handy 7.5% yield at the current share price, with our franking estimate at about 80%,” Taylor says.

Likewise, Taylor notes that the company’s planned $400 million share buyback, which is expected to finalise before the end of the calendar year, could prove timely at the current share price.

“We'd view this as an excellent use of funds while the share price is materially below fair value,” he says.

Shares in the Incitec have made a marginal recovery since Wednesday’s lows but remain at a 13% discount to Morningstar’s fair value estimate of $3.50.

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