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Orica Ltd and Incitec Pivot Limited – how will they grow?

How well can mining services companies be expected to perform if they are connected pretty much to one industry, which is soft right now? Having overseas operations may help, but what can these two companies look for in Australia?

Orica Ltd (ASX: ORI) ($23.42) is a mining explosives and chemicals producer.

In its 2013 annual report in December, the company stated that its mining services EBIT was down 2% to $993 million, and its chemical division’s EBIT was 8% down to $92 million. This was brought on by subdued conditions and weak demand. For 2014, it expects NPAT before abnormals to be higher than 2013, but present conditions make it hard to estimate.

If its products are being used for production of iron ore or coal, then the miners will still be using them, yet for exploration or greenfield development less so. Since 2009, NPAT has been relatively flat. The strong gain in 2012, brought on by the higher levels of mining activity before the slowdown, was offset by the lower results in 2013.

Going back over the past 10 years,  NPAT had a compound annual growth rate of about 5.9%, but EPS growth was even less – 3.6%. It’s in those years when mining is increasing that we see strong growth, which is intuitive. I would like to see the share price close to $15 before saying it is in bargain territory for what it has to offer in future earnings growth.

Incitec Pivot Limited (ASX: IPL) ($2.89) is a mining explosives and fertiliser producer.

Similar to Orica, looking over its past 10 years’ NPAT, we see a great increase in earnings leading up to 2008. Then downward fluctuation, until mining picked back up in 2010 – 2011 thanks to China. From there it trails down again, with NPAT going from $534 million to $299 million in 2013. The big difference between the two companies is that the number of outstanding shares increased greatly, so EPS growth is not a good way to compare the two.

Getting really simplistic, Incitec Pivot does roughly half the revenue of Orica and its NPAT is about half of Orica’s. Net profit margins in 2013 were about the same, but Orica pulled ahead in return on equity, 15.7% to 7.08% respectively.

Incitec Pivot has performed better in share price over the past 10 years and in comparison has had a higher total shareholder return, almost double, over the same time period.

Foolish takeaway

You could say Incitec Pivot had better growth rates because it was starting off on a lower base of revenue and earnings. Now as they are pacing each other more closely, the name of the game becomes getting more business and improving efficiencies – for both of them.

Investors will have to keep one eye on how the broader mining market, both domestic and international, improves over the next few years. If China and India start competing for commodities, and their stockpiles are low, we could see a resurgence in mining.

The other eye needs to be on how these two companies adjust to the new environment. Do they expand more overseas if Australia is still subdued and can they afford to do it with what they generate in earnings now?

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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