Established as a small distributor of lime in 1953, Omnia has emerged as the dominant supplier of fertiliser to the South African agricultural industry, and the most profitable manufacturer of explosives in the country. We believe the share is attractively priced and largely shielded from some of the biggest problems facing South African businesses, as will be explained.

Omnia’s two biggest divisions, Omnia Fertilizer and the explosives group BME, make up 93% of group earnings and are best in class in their respective industries. This certainly wasn’t the case 20 years ago. These divisions have been superbly managed and positioned by an astute management team with a view to building long-term winning businesses.

Omnia’s fertiliser business

Historically, the fertiliser industry in SA was dominated by Kynoch (owned by JSE-listed AECI) and Sasol, which both manufactured fertiliser locally. Ammonium nitrate is a component used in both fertiliser and explosives, which explains why AECI, the owner of African Explosives (AEL), became involved in fertiliser. Sasol produced ammonia as a by-product of its chemical processes at Sasolburg, so it made sense to convert it to ammonium nitrate. Omnia became the third entrant to the market in 1967 when it built a granulation plant in Sasolburg, and then a first nitric acid plant in 1982.

AECI exited the fertiliser industry in 2000, selling to Yara, the largest fertiliser company in the world. Today, Yara is a negligible player in the market, and does not manufacture locally.

In 2010, the Competition Commission fined Sasol’s fertiliser business for anticompetitive behaviour, and barred Sasol from having retail operations. Going forward, Sasol will continue to be a manufacturer and wholesaler only. This disruption to Sasol’s business benefited Omnia, especially considering both companies manufacture the same product: limestone ammonium nitrate.

As a result, Omnia has progressed from a distant third player in the market to the undisputed leader, with a market share of approximately 50%, according to our estimation (market share data for the industry are not published). This expansion in market share is evidenced by the phenomenal growth Omnia has achieved in its sales volumes, in what is essentially a flat market. In the past seven years, Omnia has grown its fertiliser volumes by 75% (or 8.3% per annum), while the overall market has expanded by 7.4% (or 1% per annum). If one assumes Omnia had a market share of 30% in 2008 (our estimate based on discussions with industry players), its market share today would be 49%.

Why has this business been so successful?

Good management. Omnia has a very competent management team, led by CEO Rod Humphris. The team has made some astute and well-timed investment decisions that have contributed significantly to the success of the fertiliser division. In 2011, they raised R1.4 billion in debt and equity funding for an investment in a second nitric acid complex.

At the time, management estimated that the cost of the nitric acid plant was roughly half of what similar plants had cost in other geographies a few years earlier. This was due to the fact that the pricing on the imported equipment for the plant was negotiated in the aftermath of the global financial crisis, when demand for such equipment was weak, and when the rand traded at between R6 and R7 to the dollar. The plant was delivered on budget and on time, rare for a project of this size.

The nitric acid plant provides Omnia with a source of ammonium nitrate, an essential input for both the fertiliser and explosives divisions. The investment would not have been feasible based on the ammonium nitrate demand from the fertiliser business alone, demonstrating the benefit of owning an explosives division as well. None of Omnia’s competitors – except perhaps Sasol – has the same advantage.

Superior product. Omnia manufactures a nitrate-based fertiliser called limestone ammonium nitrate (LAN). Phosphates (chemical symbol P) and potash (K) are then added to the LAN to produce an NPK compound, resulting in each granule of fertiliser having the correct ratio between nitrogen (N), phosphates and potash.

Omnia’s main competitors sell fertiliser based on urea, an organic compound containing nitrogen. This is either added to the soil on its own, or mixed with phosphates and potash to create a blend. The latter results in a bag of fertiliser that contains separate granules of N, P and K. Even distribution of each chemical across the land is therefore not guaranteed.

Nitrates are considered to be a more effective product than urea, for the following reasons:

• Due to the higher concentration of nitrogen in urea, it can burn the plant seed on contact.
• Urea needs to be converted to ammonium nitrate before it can be absorbed by plants. This process is performed by bacteria in the soil, but it takes time. As such, the nitrogen from urea is not immediately available to the plant.
• Urea is more unstable than nitrates. If left exposed to the sun on a hot day, it can break down and lose 40% of its nitrogen content.

Independent research shows that nitrate-based fertilisers can result in a 20% better crop yield than urea-based fertilisers.

Strong service model. About 90% of Omnia’s fertiliser sales are direct to farmers, and high levels of service are offered. Omnia employs a team of agronomists who work with farmers in devising solutions for their fertiliser needs. In contrast, importers tend to adopt a pure wholesaler model and do not have the agronomy skills to advise and service their clients in the same way. This has become a significant advantage for Omnia.

Omnia’s explosives business

The growth in Omnia’s explosives business has been equally impressive. In 1987, it acquired an explosives manufacturing business, Bulk Mining Explosives (BME). As with the fertiliser business, BME was a distant third player in the market ten years ago, behind Sasol and AEL (owned by JSE-listed AECI). Today, while not the biggest explosives business in the country, it is certainly the most profitable. If we take the combined profits of the two largest players in the market, and express Omnia’s profits as a percentage of this profit pool, Omnia has grown its share of profits from around 20% in 2001 to 70% today.

How has this been achieved?

A focus on the only expanding sector of SA’s resources industry: open-cast mining. BME’s main line of business is the manufacture of emulsion explosives (or bulk explosives), as opposed to packaged explosives (or shock tubes). Emulsion explosives are essentially delivered to a site in liquid form and poured into a hole before being ignited by a detonator chord. These explosives are used in open-cast mines, whereas packaged explosives are used in underground mining applications.

Open-cast mining has grown significantly in South Africa, whereas underground mining has contracted. This is due to the high cost involved with underground mining relative to open-cast. BME has therefore been positioned in the growing part of the market.

Access to ammonium nitrate.The core ingredient in explosives is ammonium nitrate, which is produced by the chemical reaction between ammonium and nitric acid. Building a nitric acid plant is, however, very expensive. Omnia spent R1.4 billion in 2011 and 2012 to establish their second nitric acid plant. This quantum of capital expenditure could partly be justified by the ammonium nitrate demand from two separate businesses, which meant that the new plant could operate at sufficient capacity to cover overheads and generate profits from day one. According to management, the new nitric acid plant operated at 60% capacity in its first year, which means that Omnia will have many years of growth before full capacity is reached.

Many of Omnia’s competitors do not have complementary businesses in explosives and fertilisers, and are therefore not able to achieve the same economies of scale. This is one of the reasons why BME generates far superior operating margins than its closest competitor, as shown in the following graph.

Less cyclical than assumed

Omnia is often regarded as a highly cyclical company due to its exposure to both mining and agriculture. While it is cyclical, we argue that it is significantly less so than, for example, a mining company or a sugar producer, for the following reasons.

Omnia’s fertiliser business is impacted far less by drought than a farmer or grower of crops. This is because the farmer typically plants his crop at the start of the season, making use of fertiliser, and then waits for the rains to fall. If drought conditions follow, the farmer suffers significantly, whereas the fertiliser company has already sold the bulk of its product. Yes, a drought is not good for the fertiliser company because of the negative impact on its customer base, but it is not nearly as damaging as it is for the farmer. This is borne out by the statistics for South African industry-wide fertiliser sales, which show a remarkably stable level of sales around the 2 million ton level for the past 32 years.

However, it must be noted that the current drought gripping the country could be one of the worst on record. Initial forecasts indicate that maize plantings could be down some 50% as a result. Consequently, fertiliser sales volumes this season could potentially decline to levels not seen in the past 32 years. We believe this is an isolated and highly unusual event and should not materially change our view on the long-term value of Omnia’s fertiliser business.

Similarly, an explosives business is far less cyclical than a mining company. An explosives business is not directly impacted by cyclical commodity prices unless the prices fall too low for a mining company to operate. What is important to an explosive company is the volume of ore being mined, which is essentially a function of the demand for the particular commodity. This demand, while still cyclical, is far less so than the commodity price.

According to Omnia’s latest interim results, BME’s volumes did decline significantly (by 21%) due mainly to the loss of two large contracts. However, the business remains very profitable, whereas the same cannot be said for many of its mining customers.

Conclusion

We are not bullish about the prospects for many South African-based manufacturing companies at the moment. Rising electricity prices and an unstable labour market are just two reasons why local manufacturers have struggled so much. Omnia, however, is largely shielded from these two issues. The company produces a significant amount of its own electricity from its nitric acid plants, and many of its facilities are automated and require limited human intervention.

Omnia is a business that has been carefully and strategically built over many decades, such that it now has a few significant competitive advantages over its competitors:

• Having both a fertiliser and an explosives business gives it both scale and flexibility in the manufacture of ammonium nitrate, an important input in the products of both divisions.
• Omnia timed the construction of its second nitric acid plant to perfection, and it was established at a fraction of what the plant would cost today. This gives the company a significant cost advantage relative to its competitors.

Omnia management has always built their business with a long-term vision in mind, and as shareholders in the business themselves, are well aligned with institutional investors such as ourselves.
Omnia has a well-capitalised and healthy balance sheet. The company has low levels of debt, and should be in a net cash position by the end of its March 2016 financial year.
These factors set Omnia apart from its competitors and should result in continuing market share gains for the company.

Lastly (but not least), all of its businesses price off US dollar commodity prices, and therefore benefit from a weak rand. Its customers will also benefit significantly from a depreciating currency.

The share is attractively priced at less than a 10 times forward price earnings ratio (by our estimates) amid the current drought conditions in SA and the huge uncertainties in commodity markets. We believe that the current valuation offers an opportunity for long-term investors to become shareholders in this quality company. It is one of the few shares exposed to the SA economy that we are comfortable holding.