Orica Limited (ASX: ORI) recently announced an impairment charge of $1.65 billion, citing a slowdown in mining as the cause. The announcement was swiftly followed by investors punishing the stock and pushing it down 17.5%. Since the sharp drop, Orica's share price has clawed back some losses and I believe it still presents a good long-term buy opportunity.
A cyclical business
Orica is an explosives and chemicals manufacturer, a highly cyclical business driven by booms in mining and construction (pun intended!). The company provides explosives and blasting systems to the defence, mining and infrastructure industries, which use Orica's product to create new mines, build new structures or for combat operations.
Orica also supplies chemicals to the mining industry that are used to extract gold and other minerals during the refining process. Accordingly, Orica's success is driven by demand for its materials, which is greatest during growth phases in any of these industries. With some analysts calling the end to a decade long mining-boom, the market's reaction to Orica's impairment suggests this is just the start of many write-downs for the high quality business. I beg to differ.
A simplified business
Orica has a history of selling its "non-core" assets; it sold paint manufacturer DuluxGroup Limited (ASX: DLX) in 2010, and its 70% stake in listed fertiliser supplier Incitec Pivot Limited (ASX: IPL) in 2006. Orica recently completed a divestment of its Orica Chemicals division to The Blackstone Group for $750 million and flagged the sale of its Minova assets acquired in 2006 "for the right price", indicating that the Orica of today is focused on one thing: explosives.
In my view, these divestments are a long-term positive for the company, as they leave the largest explosives manufacturer with a niche market to concentrate on. Whilst in the interim, Orica's earnings will need to re-base (hence the "one-off" impairment charge), over time the company should manage to generate cost efficiencies within its core business and look for reliable earnings within the explosives sector. Signs of this are already evident with management undergoing a "Transformation Program" to renegotiate long-term contracts and cut costs.
A solid income stream
In the meantime, Orica should be able to provide the patient investor with a solid income stream through dividends. The recent sale of Orica Chemicals has left Orica in a strong cash position and helped reduce debt on its balance sheet.
Management has previously indicated the potential of using surplus funds for a capital return, special dividend or share buy-back, implying shareholder-friendly initiatives in the short-term. Even if these do not eventuate, the core explosives business should generate sufficient cash flow to maintain the current dividend of 95 cents per annum. This places it on a trailing yield of 6%, providing a sustainable income in the medium term.
Foolish takeaway
Although Orica is exposed to weakness in the mining sector, current management plans should see it return to growth in the medium-term. In the interim, an investment in Orica provides a stable dividend income and the chance to be part of shareholder-friendly capital management initiatives if/when they eventuate. Accordingly, the recent price slump in Orica has provided, in my opinion, a good opportunity to buy a company with explosive potential.
