On Thursday morning, Incitec Pivot Ltd (ASX: IPL) announced that construction of its world-class ammonia plant in Louisiana, United States, is now complete with commissioning at an advanced stage. Shares in the manufacturer of fertiliser and chemicals used in industrial and agricultural production rallied on Thursday as investors cheered management's announcement that the project remained within the original budget of US$850 million.
With Incitec's shares still almost 30% off their 2016 highs of $3.98, I believe Thursday's announcement makes the stock a buy at current prices. Here's why.
Industry outlook
As I have written here previously, Incitec's key markets of ammonia and phosphate remain oversupplied with leading investments banks UBS and Credit Suisse arguing that a market glut will squeeze Incitec's ability to generate free cash flows over the medium term.
However, according to a research note issued by Deutsche Bank at the end of August, the supply side equation could soon be balanced as a result of the recent merger between Canadian fertiliser giants PotashCorp and Agrium Inc.
Deutsche Bank argues that the US$27 billion merger, which gave rise to the world's largest fertiliser manufacturer, will soon spark a flurry of further industry consolidation, leading to capacity optimisation and rationalisation. Put simply, this means excess supply should come out of the market as large players limit production to ensure a balanced market (at sustainable spot prices).
Incitec's opportunity
Whilst the latter hypothesis is still to play out, I believe Incitec's completion of its ammonia plant comes at an opportune time for the Melbourne-based company. With gas prices – the largest variable cost of ammonium production – hovering near lows, Incitec should be able to comfortably generate healthy margins at its new production facility.
Although OPEC's recent announcement to curb crude oil output could see gas prices also head higher, boding well for oil and gas producers Origin Energy Ltd (ASX: ORG), Oil Search Limited (ASX: OSH) and Woodside Petroleum Limited (ASX: WPL), Incitec should be able to withstand the incremental increase in costs through continued cost cutting via its improvement program "BEx".
Management believes BEx will be able to deliver $100 million in sustainable cash savings by the 2017 financial year. This is in addition to the $35 million annual cost cuts expected from 2019 at its Phosphate Hill plant.
Foolish takeaway
In my mind, Thursday's announcement doesn't provide any materially new information to investors. Whilst it does demonstrate management's ability to deliver projects on time, and within budget, Incitec's share price reaction appears to be driven by the market expecting cost blowouts on the project.
With a bulk of capital expenditure associated with Incitec's Louisiana plant behind it, I'd expect the market to re-rate the stock in line with global peers (which trade at an almost 30% premium, according to Deutsche Bank), boding well for Incitec's share price. Accordingly, I rate the stock as a buy today.
