bank assessment of fertilizer stox

  1. 832 Posts.
    I post this FYI only - it's Wespac assessment:

    DXL and Incitec Pivot (IPL) agree merging via a Scheme of Arrangement. Proposed terms are 0.01406 IPL plus $0.70 per one DXL. Effectively you will receive one IPL for every 71.1 DXL plus $0.70 per one DXL. You can choose all scrip or all cash, subject to limits. DXL’s Board recommends approval subject to the Independent Expert’s forthcoming report. Voting will be around June.

    Terms will adjust depending on IPL’s price at offer close. The initial $2.70 offer uses IPL’s pre-bid price of $149/share. The bid is not certain. There is no market decline out-clause. IPL cannot withdraw because the ammonium nitrate price falls or exchange rate changes. Notably IPL cannot withdraw because of any current or future Moranbah issues. This presumably means it cannot withdraw because of DXL’s contract obligations or provisions for continuing to supply key Moranbah customers. IPL will decide later whether to re-start Moranbah.

    IPL continued after completing due diligence by March 26. IPL can adjust terms effectively to $2.64/share, if its relevant 10 day volume weighted average price (VWAP) falls below $138.16. If IPL’s pre-close-of-bid VWAP falls below $126.96, it can withdraw.

    The strategic reason for merging is strong. The combined group will benefit from super cycle China and India demand for both explosives and fertilisers. IPL says this will continue for 30 years. DXL shareholders will understand Chindia’s industrialisation demand for explosives. You may be less familiar with the excellent fertiliser outlook. This is broader than just more autos and TVs across greater China.

    Ongoing population demand
    Last year the UN published its world population forecasts to 2050. These are stunning and/or alarming. World population will jump 50% from 6bn to 9bn. Continental Africa doubles to 1.9bn. Asia grows 50% to 5bn. China stays flat at 1.3bn, falling from 20% to 15% of world population. Faster-growing India stays around 17%. Europe falls from 11% to 7%. N America stays about 5%. Australia grows from 21m to 28m. Developed countries’ fertility is under half less developed rates, not enough babies. Unfortunately world arable land availability is flat, the same acreage in 2003 as in 1992. Population growth requires higher crop yields.

    As incomes lift, so does meat and fertiliser demand. Raising 1kg of beef requires three times more grain than 1kg of poultry. World grain stocks remain at 30 year lows, under eight weeks of demand, not forgetting biofuel. Supply shortages plus growing demand equals bumper prices with high gas input costs also pressurising nitrogen fertiliser. Spot fertiliser prices are over four times 10 year averages, Diammonium Phosphate (DAP) around US$1,000/t. IPL forecasts FY08 EBIT doubling to around $720m. It assumes DAP also doubling to around US$775/t, despite a higher A$ and perennial Phosphate Hill mining hiccups.

    Major fertiliser producer Yarra International market cap $18bn bullishly said this February phosphate availability is not even close to matching demand. Phosphate explorers are naturally appearing, like Bonaparte (BON) or Minemakers (MAK). Yarra’s co-owner of WA’s Burrup Fertilisers may still launch its $600m IPO, markets willing – please refer to our April 2006 Orica report.

    IPL trebled FY07 EPS both from higher fertiliser prices and from including its first full year from Southern Cross Fertilisers, adroitly bought from BHP on 0.7 times FY07 EBITDA. Financial management is also solid. Its cost-cutting program exceeded target by $48m. How Orica must regret selling its 71% of IPL at $21/share mid FY06!

    Will record fertiliser prices hold?
    IPL’s strategy of combining fertilisers with explosives is exactly opposite to why Orica sold, preferring just explosives. IPL will not buy DXL as cheaply as Southern Cross. Its timing is still opportunistic, using its highly-priced scrip with little cash. Does the enlarged group’s further upside justify this? DXL shareholders will receive capital gains tax rollover relief.

    Assuming the merger votes through, the combined group’s September FY08 year will include only around three months from DXL. IPL’s standalone FY08 NPAT will double to around $500m mainly on higher DAP prices, FY09 holding. Industry forecasts DAP staying high for three years.

    DXL’s stand-alone FY08 and FY09 EPS grow more modestly around 15% and 9% respectively, mainly from Cheyenne’s expansion. The combined group pro-forma FY08 EPS grows far more than DXL stand-alone. Provided DAP holds, group FY09 EPS will also grow around 19%. Longer-term growth will be above DXL’s standalone growth. DXL shareholders will also benefit from higher franking. Gearing will be high around 147%, using net debt/equity. This assumes DXL’s hybrids (DYNPA) convert at their high takeover conversion ratios. IPL has already secured $2.4bn debt for the merger, terms undisclosed.

    Basically, DXL will receive longer term fertiliser upside and more shareholder friendly management. The offered terms are not generous. DXL is too vulnerable from its Moranbah woes to attract better. Rival offers are unlikely. Orica cannot bid. Rival international fertiliser majors like Yarra or Agrium are possible but have limited explosives knowledge unlike IPL.

    On preliminary estimates, IPL values DXL at an enterprise value – market cap plus net debt – of $3.3bn including hybrids. This is a reasonable 12 times trailing CY07 EBITDA or a less generous 10 times forecast DXL CY09 EBITDA. The combined group’s FY09 EBITDA will treble IPL’s standalone FY07 $349m EBITDA, assuming a relatively high $US$760/t DAP and 85c A$/US$. Forecasts are highly sensitive to the DAP price. Using the five year average DAP price of US$320/t, ie 60% less, reduces group FY09 EBITDA 40% to around $650m. This puts the group on very high multiples, 29 times PER or 14 times EV/EBITDA.

    Effectively IPL is betting on continuing very high fertiliser prices, which will also support strong explosive prices. IPL will take out costs, but not enough to offset a 60% fertiliser price fall if it’s wrong. DXL shareholders will benefit from higher short term dividends with spot prices holding around US$750/t.

    Soft commodity downturns can be swift, however hungry the world. Longer term investors will prefer IPL’s proven management than DXL’s unproven. DXL’s $2.37 IPO investors are finally ahead. There is solid long term fertiliser demand. We’d rather re-enter at less extreme fertiliser or IPL prices. That could be a long wait, so Hold/Accept.

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