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Why Orica Ltd may have become the latest blue-chip to buy

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Shares in Orica Ltd (ASX: ORI) was one of the best performing stocks on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) on Tuesday with the stock surging 5.5% to a two-month high of $19.48.

A massive valuation upgrade by Morgan Stanley probably had something to do with the sharp rally in the stock with the broker increasing its price target on the explosives and chemicals group to $21.20 from $16.50 a share and changing its recommendation on the stock to “overweight” from “equal-weight”.

Today’s jump marks a dramatic turnaround in sentiment towards Orica after it was sharply sold off in November last year when it posted a disappointing full year result.

“Our forecasts now reflect increased confidence in the commodity cycle. We believe that recent commodity price strength will prove a precursor to expansionary activity,” said the broker.

“We now expect a 4% explosives volume CAGR for ORI over the next three years (vs 2% previously).”

Orica’s explosives are used by miners and the ongoing resilience of the commodities market is expected to prompt many of them to expand or start new mines to meet demand.

The bullish sentiment is already evident in the mining sector with heavyweights like BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) outperforming the broader market and other household blue-chip names like Commonwealth Bank of Australia (ASX: CBA) and Telstra Corporation Ltd (ASX: TLS).

However, this bullish sentiment is yet to spread to Orica with the stock climbing less than 3% over the past 12-months when the ASX 200 benchmark is up 7.6%.

“We believe that renewed confidence in the underlying explosives demand backdrop is increasingly prevalent within the investment community,” said Morgan Stanley.

“However, ORI’s earnings leverage to increased volumes is underappreciated, in our view. We have upgraded EPS forecasts by 3-12% over the forecast period.”

On the other hand, Orica’s peer Incitec Pivot Ltd (ASX: IPL) has not enjoyed the same recommendation upgrade from the broker as it is more exposed to fertiliser prices, which are expecting to moderate this year, according to Morgan Stanley.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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