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Opportunity in Omnia

Opportunity in Omnia

Omnia is a diversified group that supplies chemicals and specialised services to the chemical, mining and agricultural sectors in Africa. Although the company has generally delivered good returns over the long term, recent earnings have been weak. Omnia has made considerable capital investments over the last five years, which are expected to result in meaningful cost savings in the future.

Omnia underperformed materially in 2019, owing to cyclical headwinds in several of their end markets coupled with a weak balance sheet (following years of heavy investment and poor working capital management). In the same year, the company was forced to undertake a rights issue and the proceeds were used to reduce debt and substantially strengthen capital structure.

The rights issue presented an attractive opportunity to build a meaningful Omnia position in our clients’ portfolio. We see that Omnia continues to be a dominant player across key markets and we set out below where the future opportunities lie across the group’s divisions.

A differentiated agricultural business
Regarded as South Africa’s leading fertiliser producer, Omnia has a relatively new and sizeable low-cost manufacturing footprint, providing them with a competitive edge against local importers and blenders.

The company manufactures and sells ammonium nitrate-based fertilisers as opposed to low-cost urea-based fertilisers that are preferred in many emerging markets. Compared with the latter, ammonium nitrate-based fertilisers have proven agronomic benefits, such as reduced soil acidification, improved water efficiencies and better root development. Ammonium nitrate is also a basic building block in the production of explosives and Omnia’s existing fertiliser scale gives it a key cost advantage compared to its competitors, as the fixed cost base is spread across two end markets. This results in a lower unit cost of production in both businesses and better returns on capital.

Fertiliser consumption in South Africa has been relatively static over the past decade, however, competition has recently intensified, placing pressure on Omnia’s margins. Although there appears to be a large growth opportunity in Africa – where fertiliser application rates per hectare are very low – challenges around a lack of funding for small and medium-sized farmers, and the slow shift to more modern farming methods, has limited the size of the opportunity.

In response to challenging local fundamentals, Omnia has shifted their focus to bio-agricultural products and services. Unlike traditional fertiliser products that are largely commoditised, bio-agricultural products are highly specialized and need to be registered in each country they are sold. This offers a significant barrier against competition.

With farmers increasingly looking for safer and more environmentally-friendly fertiliser and crop protection solutions, the bio-agricultural market is growing rapidly. Omnia is well positioned to capitalise on this shift, especially with its recently acquired Oro Agri business.

Meaningful value in mining
Omnia’s mining division comprises two separate businesses: BME (manufactures explosives) and Protea Mining Chemicals (supplies specialised niche chemicals to customers in the mining industry).

BME operates throughout Africa (with a strong presence in the Southern and Western parts of the continent) and is a market leader in bulk emulsion and blended bulk explosive formulations for the opencast mining industry. Omnia’s key competitive advantage in explosives stems from their proprietary double salt emulsion formula that allows them to use a high percentage of used oil in the manufacturing of explosives. Emulsions in explosives typically contain oil that can either be diesel, a derivative of diesel or used engine oil. Omnia’s double salt emulsion is very stable compared to competitors and BME has successfully produced emulsions containing 80% used oil. This is beneficial in that it lowers the cost of production and greatly assists mining companies in safely disposing of significant amounts of waste oil.

Blast safety and efficiency have become the primary concerns for most mining customers, resulting in the development of more sophisticated blasting techniques. Again, Omnia is well positioned here given the significant investment into their world class AXXIS™ suite of products. Mines are now able to design, simulate and optimise blast patterns by using software exclusively developed by the business. Furthermore, this software can be paired with Omnia’s AXXIS™ detonators and Centralized Blasting System, which initiates blasts from a remote location, thereby substantially reducing safety risks and blast costs.

Chemical cluster is challenged
Omnia’s third and smallest division is its chemicals business (largely a chemical trader), which procures speciality chemicals globally and resells them into the local and sub-Saharan Africa markets. While operating margins are low at around 3% and working capital tends to be high, the division houses several attractive niche and high-margin businesses in the water treatment and consumer chemical markets.

The chemical division has struggled to deliver a reasonable return on capital over the last decade despite multiple attempts to restructure the cost base. There are no definitive synergies between this business and the rest of the group. However, with new management at the helm and amid a broader group restructure, we see potential for its disposal, which could unlock meaningful value.

World class asset base at a deep discount
With a rich asset base of over 50 manufacturing sites in South Africa and abroad, the Omnia Group has built up a network of 11 world-class chemical and agriculture laboratories in five countries, including an extensive global distribution network.

Omnia is the largest nitric acid manufacturer in South Africa, with two nitric acid plants. The newest plant (built at a very low capital cost relative to similar global projects) enjoys a large competitive advantage locally. The company has negligible exposure to carbon tax on emissions due to prior investment in world-class nitrogen oxide (NOx) abatement technology and key plants have ample capacity for future growth. Additionally, the plants are younger and more efficient than those of competitors, providing a lower cost of production.

While the latest plant was built for R1.7 billion in 2011, the current replacement cost is much higher. Polish fertilizer company, Orlen SA, recently announced the build of a similarly sized nitric acid plant with the same kind of abatement technology, for over R5.1 billion.

Another key investment has been in the construction of a new nitrophosphate plant, which further strengthens the company’s competitive position and lowers the cost of fertiliser production more.

Omnia currently procures phosphorous (an important ingredient in fertiliser blends) from Foskor at very high prices. Foskor has the local monopoly due to its control over the Phalaborwa Igneous Complex, the larger of only two commercially viable onshore phosphorous deposits in South Africa. However, Omnia’s new nitrophosphate facility allows them to substitute more expensive phosphoric acid purchased from Foskor, with cheaper phosphate rock. In addition, the plant will produce calcium nitrate liquid, which is a key input into products produced by the explosives and speciality fertiliser businesses. The plant started production in late 2019 and is expected to deliver significant cost savings in addition to large working capital benefits.

As charted below, Omnia has invested heavily in its business over the past decade and we estimate the replacement cost of the asset base to be well in excess of R10 billion. This compares to a current market value of only R3.5 billion, allowing investors to buy a world class asset base at a deep discount.

Large cost opportunities
Omnia’s earnings today are well below what we consider normal, owing largely to an aggressive growth strategy between 2017 and 2019, which resulted in significant cost growth, cyclical headwinds across key end markets and poor working capital management.

While the company’s growth strategy and investments to date have not yet delivered the requisite value to previous shareholders, a comparison of Omnia’s key financial metrics (relative to its global and local competitors) highlights significant potential to reduce costs and working capital intensity, and improve profitability (chart below).

The rights issue in 2019 presented us with a unique opportunity to buy a business with some enduring strengths at a deep discount to its asset value. Under new management, a leaner and more focused business has the potential to deliver significant medium-term earnings growth. While the turnaround may take some time, there are several large opportunities available to unlock value and we believe that patient investors will be well rewarded.

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