There may not be as many bargains now that the S&P/ASX 200 Index (Index:^AXJO) bounced strongly from last month’s low. But there are still select stocks that remain oversold from the COVID-19 market shakeup.
One such stock is Orica Ltd (ASX: ORI), according to UBS, which just upgraded the explosives maker to “buy” from “neutral”.
The Orica share price tumbled by over 25% over the past two months and the broker believes too much bad news have been levied onto the stock.
Too much pessimism in the stock
Orica is the leading supplier of explosives to the mining industry, a sector that is holding on better than most during the coronavirus-triggered bear market.
“The current share price is trading slightly above our new downside scenario valuation of $16.36, which implies a c10% decline in AN [ammonia nitrate] volumes (FY19-21),” said UBS.
“This assumes an aggressive c.6mths of disruption to global mine production vs the 2-3 months that we are currently forecasting in our base case.
“A 10% decline would exceed the largest AN volume declines in the prior cycle of c6% (FY16), when commodity prices were less supportive vs current prices.”
Bang for your buck
It seems unlikely that demand for AN would drop over the medium term given that mining activity, particularly among the bulk commodities, is forecast to remain reasonably strong during the post COVID-19 recovery phase.
For instance, the iron ore price is proving resilient and that bodes well for explosives demand as miners like Fortescue Metals Group Limited (ASX: FMG) and BHP Group Ltd (ASX: BHP) try to boost output to capitalise on the current operating environment.
Detractors would point to the shutdown of mines in some countries to curb the global pandemic and the delay in starting Orica’s Burrup facility due to the cyclone.
But these headwinds are already accounted for in Orica’s share price, according to UBS.
The company also recently undertook a $517 million capital raising to fund the acquisition of Exsa in Peru, which is also in the broker’s earnings estimates.
“The stock now trades at a FY21 P/E (UBSe) of 15x, vs the typical multiple of 18x where the stock has traded during similar phases of the commodity cycle,” added UBS.
“Post the recent (pre COVID-19) equity raising, we believe Orica’s balance sheet is in a strong position.”
UBS’ price target on Orica is $21.38 a share. This implies around a 30% upside for the stock if you included dividends.
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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited. The Motley Fool Australia has no position in any of the stocks mentioned. 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 Scott Phillips.
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