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Why Morgans just upgraded the Orica (ASX:ORI) share price to “buy”

share price boom Orica upgrade

The Orica Ltd (ASX: ORI) share price is outperforming on Monday after a leading broker upgraded the stock.

The Orica share price jumped 1.4% to $16.50 when the S&P/ASX 200 Index (Index:^AXJO) gained 0.5%.

Optimism about a COVID‐19 vaccine is fuelling the market rally and the good times are likely to roll into early 2021.

Why Orica scored a broker upgrade

There’s also good upside for the ORI share price, according to Morgans which lifted its recommendation on the stock to “add” from “hold”.

The decision came after Orica posted its FY20 results with second half earnings looking particularly weak.

The explosives maker’s operating net profit crashed 20% to $299.3 million, which was 9% below Morgan’s forecasts and 7% under consensus.

Headwinds not enough to stop the Orica share price

This is largely due to one-off factors while COVID disruption had the greatest impact on Orica’s second half volumes in developing markets, like Latin America and Asia.

Operating cash flow was also weaker than expected as that more than halved to just $277.4 million from $746.4 million in the previous corresponding period.

But these negatives aren’t enough to worry Morgans.

Valuation upgrade

“While a weak 1H21 result was flagged given persisting COVID-19 headwinds in emerging economies, strong growth is expected from the 2H21 onwards as COVID-19 is cycled and underpinned by ORI’s five strategic growth priorities,” said the broker.

“This has seen us upgrade our FY22/23 forecasts.”

Orica is expecting an improved FY21 earnings before interest and tax (EBIT) figure as its weak first half is more than offset by the recovery in the latter half.

Orica’s earnings growth drivers

The key growth levers include a $40 million to $50 million boost from Orica’s portfolio and IT system optimisation programs.

It will also get a further $20 million EBIT boost from 12 months of production from Burrup and an extra $20 million from its Exsa acquisition.

“While not quantified, further earnings growth is expected from Minova and GroundProbe in FY21,” said Morgans.

“Overall, group AN [ammonia nitrate] volumes (ex. Exsa) are expected to rise by c1%.

“Driven by an easing of COVID-19 related volume and cost headwinds and ongoing incremental contribution from its strategic priorities, management expects a further improvement in FY22 EBIT to cA$720-730m with clear drivers in place to deliver growth out to FY24.”

Morgans upgraded its 12-month price target on the Orica share price to $18.95 from $15.55 a share.

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Returns as of 6th October 2020

Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. 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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