Global market leaders in the ammonium nitrate explosives business, and significant suppliers of chemicals and reagents to mineral processors, too, ASX-listed Orica (ASX: ORI) and Incitec Pivot (ASX: IPL) are shadows of their boom-time selves. The former’s share price has slid about 21.5% over the past 12 months; Incitec 28%. They were down in the past week by 3.3% and 9%, respectively.
Orica’s market cap this week was about US$4.31 billion; Incitec’s $3.82 billion.
Morgan Stanley suggested in the past week the “accelerating” structural decline of the US coal industry further darkens the sales and profit horizons of explosives (and bulk consumables) suppliers. The bank said falling US coal production was expected to pressure Orica’s and Incitec’s profitability.
“After falling about 11% in 2015, the EIA [Energy Information Administration] estimates US coal production has fallen another 39% yoy through to March 19, 2016, as production is impacted by low coal prices, substitution to gas and the impost of increased environmental regulation,” it said.
“If this pace is sustained, aggregate US coal production is on track to fall to levels last seen in the early 1970s. As the second largest explosives market for both ORI and IPL – ORI holds additional exposure through Minova – and with coal representing 40-50% of explosives demand in the region, this decline represents a significant and growing threat to profitability.”
Morgan Stanley said North America was not a major importer of ammonium nitrate, meaning the offsetting balancing item of weaker demand was lower AN plant utilisation. Last September Incitec was saying industry-wide North American AN plant use was about 80%.
“Even assuming high single-digit percentage growth in quarrying and construction demand since, we expect industry utilisation likely now sits closer to about 70%, implying some plants may now be marginal,” the bank said. “As a result further capacity rationalisation now looks to be required. Both ORI (about 550,000 tonnes) and IPL (about 800,000t) still hold substantial North American production capacity which we expect will be increasingly pressured.
“Indicative of this, despite more measured falls in coal production through 2008-2015, IPL has already shuttered more than 300,000t of capacity and ORI about 60,000t.
“To date we believe the general investor perception has been that US coal weakness was largely confined to the higher cost Appalachian [eastern US] region, therefore limiting the broader expected impact on the explosives industry. While previously true, this ceased to be the case from October 2015 since when all regions have experienced a similar and accelerating pace of decline.
“Although ORI and IPL argue their remaining AN supply is cost competitive, this is on a plant gate basis (before freight). However, plant footprints and freight differentials will increasingly matter in determining the true competitiveness of individual plant economics. As demand weakens the natural catchments for which each plant was designed may no longer be sufficient to support adequate plant utilisation – thus freight would need to be incurred to move the AN to where there is demand making this the more relevant cost metric.”
And while the explosives industry had argued the quarrying/construction market would provide some utilisation reprieve, it was unlikely to be a substantial offset “as it makes up only about 25% of North American demand while coal remains a major demand driver across most regions”.
