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Top broker says “buy” Orica shares before its Friday profit results

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There’s a sense of anticipation that the Orica Ltd (ASX: ORI) share price could stage a recovery when it releases its first half profit results on Friday.

Shares in the explosives and chemicals group have fallen by around 23% since the start of the year and the S&P/ASX 200 Index (Index:^AXJO) company become one of many to raise capital during the COVID-19 crisis.

But it isn’t so much the earnings numbers that could trigger a rebound for Orica. If the stock runs, it will be more likely due to its outlook statement.

Potential tailwinds

Spot ammonia nitrate (AN) prices have improved by mid-single digits since Orica last reported its interim results in 2019 and demand for its class leading explosives used in mining is picking up, according to Citigroup as it upgraded the stock.

Brokers would normally wait to see the earnings report this close to the release before changing their recommendations. But Citi must be pretty confident that Orica will get a good reception as it lifted its rating on the stock to “buy” from “neutral”.

While the increase in the AN price isn’t expected to give a material short-term boost to Orica’s earnings, it creates a favourable backdrop when Orica renegotiates major contracts before FY22.

Blasting away

Meanwhile, rising strip ratios reported by miners bodes well for explosives demand. A higher strip ratio means miners will have to blast more rock to extract minerals.

Iron ore miners like Fortescue Metals Group Limited (ASX: FMG) and BHP Group Ltd (ASX: BHP) are ramping up production to capitalise on the relatively strong iron ore price.

Things to watch

There are a few key things to watch for in the results, added Citi. The impact of COVID-19 on the supply chain and end user demand is one.

Investors will also be keen to get an update on Orica’s troubled Burrup asset and to hear an update on the completion date for Exsa.

Any guidance on volumes and earnings will also likely move Orica’s share price on the day.

Valuation down but recommendation up

“Orica has a dominant position in the global explosive sector being driven by its intellectual property, particularly in wireless blasting systems,” said Citi.

“The company’s globally diversified earnings are underpinned by multi-year contracts with major miners.

“Given the share price fall and our assessment of risk around earnings and the balance sheet, we upgrade to Buy.”

However, Citi lowered its target price on the stock to $19.40 from $24.50 a share to account for the dilution from Orica’s $500 million plus capital raise and contraction in market multiples.

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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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