Is Orica set to experience an explosive turnaround?
It was a long time coming, but the eventual sacking of Orica Ltd's (ASX: ORI) former boss Ian Smith last March (whose aggressive management style was legendary) and the confirmation of the new CEO Alberto Calderon late May, marked a major milestone for the mining explosives firm, and the market is already talking of a turnaround story in the making.
Having been a non-executive director since August 2013, Mr Calderon, a former BHP boss, is under no illusions over the myriad operating challenges confronting the business. None the least of these challenges is driving efficiencies, while the outlook for ammonium nitrate (AN) prices remains weak due to oversupply issues, and commodity prices that continue to slump.
Mr Calderon is the change-agent that the board thought they were getting when then mistakenly hired Smith. But having dumped Smith three years into a five-year contract, the board is desperate for a CEO who can deliver results.
Unsurprisingly, Mr Calderon got straight down to business by reducing Orica's AN production capacity by 50% at Yarwun in Queensland – which is expected to result in net cost savings of around $8 million annually, and subject to approvals, plans to ramp up ammonia production at its Kooragang Island facility.
Orica has already cut 1300 positions in the past two years in response to challenging market conditions, and Mr Calderon has accelerated the cost-containment by cutting an additional 40 jobs from the Orica workforce at Yarwun, Gladstone, and throughout 2015 a total of 700 jobs will be cut from the Orica payroll.
But on a brighter note, what's given shareholders something to cheer about were revelations in June that Orica had won a contract to provide a variety of drilling, blasting, and supply services for PhosAgro's Apatit operation in Russia, worth around $300 million.
Orica's share price reached a nine month high mid June ($22.56), following announcements it thought 2015 would mark the bottom of the cycle for the mining industry, but these gains were short lived following a further softening in iron ore prices. While increasing iron ore volumes does help to underpin the Orica share price at current levels, what the market clearly wants from Mr Calderon is greater clarity around the shape of his turnaround story.
Mr Calderon's plans to go on saving money and running production at levels more consistent with supply-demand is encouraging. But what the market particularly wants to hear are his plans to reignite its downgraded outlook for explosives sales.
The market also wants to know how Mr Calderon will aggressively chase the top three iron ore majors in the Pilbara – Rio Tinto, BHP and Fortescue – where Orica has little current exposure. With most of the Pilbara contracts up for negotiation in the next two or three years, the upside for Orica looks encouraging.
Given the capacity issue confronting the industry, Orica's margins have come under serious pressure, with net profit from continuing operations falling 3 per cent to $211 million for the six months ended March 31. While the share price is trading slightly above intrinsic value, it still presents a 24% discount to broker target prices around $26.75.
But this forecast looks ambitious without further revelations from Mr Calderon about what he has in store for the business. Weakening earnings per share (EPS) growth is forecast for the stock, and while return on equity (ROE) has averaged 19.50% since 2005, it is expected to weaken. Watch the commentary accompanying Orica's full year result closely for clearer evidence that talk of a turnaround isn't just the market getting ahead of itself. Future acquisitions would be concerning given the stock's $2.7 billion funding gap.