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Orica: Its bang might not be worth your buck

Orica (ASX: ORI) is a provider of explosives and blasting systems to the mining and infrastructure sectors. With the tailwind of the mining boom, Orica has managed to grow profits year after year for shareholders. From humble Australian beginnings, by producing a high quality product at a reasonable price the company now commands a significant share of the global explosives market.

However as Foolish investors know, in investing, valuation is the key. No matter how wonderful a business may be, at certain prices you are unlikely to get a reasonable return on your investment. The tough question for investors as Orica’s share price sinks to a four-year low is, has the ‘mining bust’ been fully priced into the share price or is there further to fall?

To help answer that question, a little recent advice from Bill Gross who is the managing director of PIMCO, the world’s largest bond fund could help. Gross is a deep thinker and thankfully regularly shares his thoughts with the public via his Investment Outlook notes. In a recent note, Gross mentioned that he recently tweeted (he’s very tech savvy!): “Never have investors reached so high in price for so low a return. Never have investors stooped so low for so much risk.”

The tweet is pretty clear, but just to be doubly clear, Gross, who is looking back over decades when he makes this tweet is saying, never have investors received less for the risk they are taking.

His statement applies to stocks just as much as to bonds and should remind investors to put investment decisions into a long-term context.  Back in 2004, Orica’s earnings before interest, tax, depreciation & amortisation (EBITDA) margin was 15.65%, come 2011 it had increased to 21%. Part of this margin expansion is no doubt efficiency gains which may or may not hold should volumes decrease. However part of this margin gain is surely also boom time supply-constrained/demand-driven pricing power.

Foolish takeaway

While Orica and its major competitor Incitec Pivot (ASX: IPL) are looking appealing from a valuation point of view, investors need to tread carefully at this point in the cycle as earnings could have further to fall.

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Motley Fool contributor Tim McArthur has no financial interest in any company mentioned in this article.

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