Incitec Pivot Ltd (ASX: IPL) manufactures chemicals used in industrial and agricultural production. The company formed following a merger between Incitec Fertilisers and the Pivot Group in 2003 to create what is now the second-largest fertiliser and explosives maker in the world, behind listed peer Orica Limited (ASX: ORI).
At the start of January this year, Incitec issued a $14 million profit downgrade following the derailment of a supply train operated by Aurizon Holdings Ltd (ASX: AZJ), sparking a 25% sell-off over the month of January. When compared to the S&P/ASX 200 Index (ASX: XJO), which closed marginally lower over the same period, Incitec's downgrade appears fully priced-in with limited downside.
Here's why I think it is a buy today.
Train derailment
On 27 December 2015, Aurizon's supply train derailed near Julia Creek in Queensland. It was carrying 200,000 litres of a key ingredient for making fertiliser — for use at Incitec's flagship Phosphate Hill production facility. The incident is expected to wipe a one-off $14 million from full year net profit after tax (NPAT), equating to 3.5% of 2015 full year NPAT. By contrast, Incitec's share price has crashed 25% amidst global gloom, implying the sell-off might be overdone.
Production targets
Importantly, Incitec's management has been active and opted to bring forward maintenance to offset any loss in production of phosphate fertiliser. Accordingly, management reiterates that Incitec is still 'on track' (pun intended) to reach its 950,000 tonne production target at Phosphate Hill, despite the derailment.
As such, NPAT should go largely unaffected by the train derailment.
Outlook
A key risk, and possible reason, for why Incitec has suffered such a dramatic fall in share price is the cutback in exploration expenditure by oil and mining companies. Incitec's second core business is explosives used in mining and oil exploration and production. Amidst the commodity meltdown, investors have assumedly grown weary of decreased demand for Incitec's explosives business, marking down its shares in anticipation of weak results later this year.
Positive steps
The reality is that management has already taken positive steps to brace for a mining slowdown. Incitec has invested heavily in its fertiliser business by constructing a state-of-the-art ammonia production facility in Louisiana, U.S.
First production from the new plant is due in the second half of this year. This coincides at a time where gas prices, which account for 75% of the cost of producing ammonia, are at all time lows. The continuing depreciation of the Australian dollar against the US dollar also means earnings from this project are likely to receive a translational benefit when Incitec reports later this year in May, making Incitec's investment decision into Louisiana well timed.
Strong balance sheet
Finally, Incitec's strength lies in the quality of its balance sheet. Despite the ongoing investment in the U.S. and decreased demand for its products, Incitec slashed net debt in 2015 to $1.3 billion (from $1.5 billion) using free cash flows. Earnings in its fertiliser business grew 22% year-on-year and net profit jumped 9% to $398.6 million.
Whilst the further deterioration of commodity markets means those results are unlikely to be repeated this year, Incitec's strong cash position should see it through any market weakness, making for a compelling investment today.
Foolish takeaway
Although it is unknown when the mining slowdown will end, Incitec Pivot has the right formula to make for an explosive comeback when the commodity cycle turns. In my opinion, the current share price does not reflect management's long-term strategy of reinvesting in its core businesses to increase productivity, thus I believe investors should buy at current prices to reap rewards in the future.
