march quarter_bourse (002) | Page 14

COMPANY NEWS & UPDATES

Orica Limited ( ORI )

Accumulate Valuation $ 17.50

Earnings Forecast

* Profit & EPS adjusted for options , goodwill , notional earnings and nonrecurring items .

Short-term Impacts on Earnings

We make no change to our valuation for Orica . That ' s despite reducing our FY21 EPS forecast by 29 % to $ 0.55 . We see no longer-term implication in the drivers of the EPS downgrade . Orica reported a number of likely temporary factors impacting on firsthalf FY21 EBIT .

The global explosives provider says :

1 . trade tension between Australia and China is impacting demand in the higher margin Australian thermal coal market ;

2 . COVID-19 continues to be a source of uncertainty , including mine closures and social unrest in Colombia , Peru , and Chile , temporarily driving an unfavourable shift in product mix ; and

3 . strength in the Australian dollar and additional arbitration costs for the Burrup ammonium nitrate plant

have impacted negatively . All up , Orica estimates $ 105 million to $ 125 million EBIT detraction from firsthalf FY21 . That ' s a material hit given full-year FY20 underlying EBIT came in at $ 605 million . Our FY21 EBIT forecast declines by 20 % to $ 490 million .

We reduce our FY21 DPS forecast to $ 0.275 from $ 0.385 , assuming a 50 % payout ratio . It equates to a modest 2.0 % unfranked yield at the current circa $ 14.30 share price . But we expect sharp recovery to in excess of $ 0.50 by FY22 .

Orica shares have recovered some of the lost ground ceded post the lacklustre trading update but remain undervalued . Our unchanged valuation equates to an underlying FY25 EV / EBITDA of 6.6 , a P / E of 13.7 , and a dividend yield of 3.7 %. We still credit Orica growing revenue at a healthy 5.6 % CAGR to $ 7.4 billion by FY25 , from the COVID- 19-impacted FY20 $ 5.6 billion dip .

This assumes global mining volumes recommence a steady rise , COVID- 19 is only a temporary hiccup , and mining activity becomes increasingly difficult as ever more overburden removal is required .

We also expect more uptake of technology-based productivity solutions to improve EBITDA margins to a mid-cycle 22 % from 16 % actual in FY20 . Together with increasing revenue , our forecast margin expansion drives strong 13 % EBITDA CAGR to $ 1.6 billion by FY25 , again flattered by the virusimpacted start year .

Material ESG exposures create additional risk for investors in explosives companies like Orica . The most significant exposures are greenhouse gas emissions from manufacturing , and other emissions , effluents , and waste primarily consisting of dangerous chemicals . In addition to the reputational threat , failure to meet targets could force climate and environmentally conscious consumers away from Orica ' s products resulting in longterm demand erosion . Climate concerns could also trigger regulatory interventions such as direct taxes on carbon emissions , already in place in some jurisdictions .

These ESG risks are based largely on industry risks that are already incorporated into our base-case analysis . And some elements of ESG risk , like potential for spills of dangerous waste are further captured within our high valuation uncertainty rating and WACC . Orica is increasingly attempting to defray emissions from its operations , the company aiming to cut its annual greenhouse gas emissions by 40 % by 2030 from FY19 levels . It is off to a good start having reduced emissions by 9 % in FY20 and 6 % in FY19 .

Orica operates in an energy intensive industry , with natural gas used both as an energy source and as raw material in the manufacture of nitrogen-based products . The company is faced with the need to decrease its carbon emissions in order to avoid compliance risks ,

Page 14 of 21