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Toiling Incitec looks to farmers and bank traders

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Incitec Pivot is turning to investment bank traders for methodology in managing its fertilizer position, and pressing farmers to bear more of the risk of volatile prices, after suffering a slump in profits at its nutrient division.

The group, Australia's biggest fertilizer producer, said that underlying earnings fell by 24% to Aus$404.7m in the year to the end of September.

While Incitec said that operating profits from explosives, of which it is the world's second-ranked manufacturer, grew 8.4% to Aus$399.9m, those from fertilizers tumbled by 40% to Aus$270.9m "reflecting the impact of fluctuating global prices".

The losses included, for instance, a hit on purchases of urea and ammonium phosphate made in advance, during last year's more robust markets.

Inventory limits

The group said it was responding to the setback in part by implementing so-called "value at risk", or VaR, monitoring to its fertilizer operations.

This methodology applies an estimate of the likelihood of an asset suffering a given drop in value over a set timescale, and is employed notably in investment banks to gauge the level of risk in their portfolios.

Incitec Pivot said it would use the technique "to limit the size of long inventory positions across the combined fertilizer business", that is to cap its exposure to a drop in prices.

Indeed, James Fazzino, chief executive, said the group would stop fertilizer imports, which represent a ready source of controlling its inventories, if the risk of price volatility was too high.

"At certain times, we may not be able to meet uncommitted market demand if we deem the price risk to be outside our pre-determined thresholds," he said.

'Going to have to commit'

Furthermore, Incitec Pivot said it would press growers to sign up in advance to commit – irrevocably – to fertilizer purchases, at set prices and times, so passing to them the risk, and upside, from changes in market conditions.

"We are having a conversation with our customers now, saying 'if you want the fertiliser, you're going to have to commit in terms of the volume that you want and also the price that you're going to pay'," Mr Fazzino said.

"We're putting in place firm contracts that lock in both price and volume rather than conducting business on a spot basis.

"This gives increased certainty to us and customers."

Global issue

The move represented the group's solution to what Mr Fazzino said was a global problem for fertilizer groups, given the "trend for ongoing volatility" in commodity markets.

"This increases the price risk in any distribution business, particularly one with a long supply chain as is the case with our domestic fertiliser business.

"The implication of this volatility is that fertiliser distributors globally, including Incitec Pivot, have recorded significant losses in recent years, particularly in 2008, during the global financial crisis, and 2012, during the European financial crisis."

And it moves the group's fertilizer business more towards that in explosives, which the company supplies largely through long-term contracts.

Explosives vs fertilizer

Indeed, Mr Fazzino termed the explosives business Incitec Pivot's "growth platform", which was set to account for an increase proportion of group earnings.

"While we concur with suggestions that Australia could become the food bowl of Asia, cash flows are less predictable in this business than in explosives," he said.

Incitec Pivot shares closed up 3.8% at Aus$3.02 in Sydney.


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