2001 Securities Institute Presentation

Presentation by CEO Philip Weickhardt to the Securities Institute in Melbourne, Australia, on Wednesday 21 March 2001.

Some of you actually might have come here with the incorrect impression that chemical companies are old world, rather boring and likely to yield low or unexciting returns. I hope I can convince you today that you’re wrong. Indeed, some of you may have recently read Warren Buffett’s entertaining epistle in his annual report, to the shareholders of Berkshire Hathaway. And there he says in this year’s version: "We’ve embraced the 21st century by entering such cutting edge industries as carpet, insulation and paint. Try to control your excitement."

I hope you share his and my conviction that these sorts of businesses are not old and boring and, indeed, can yield excellent returns.

The areas I want to cover today include an outline of Orica’s strategy and the reasons for it and a description of the changes we’ve made in recent years, an analysis of what’s gone well and what’s not and what we’re doing about it, and an outline of where to from here.

I trust that when I’ve finished that you will understand why we’ve set out to radically reshape Orica and what we’ve still to do.

Importantly, by the time I’ve finished, I hope you will share my conviction that Orica really does have the potential to again become a business recognised for generating superior shareholder returns.

So let me begin the Orica story. We’ve made enormous changes to the company over the last four years, mostly due to consciously implementing strategies which we’d spent a lot of time thinking about.

It’s natural, given our share price over recent years, for people to ask questions like, ‘is the strategy right, is this portfolio really capable of making superior returns, or is the current performance a reflection of poor execution, or an unlucky combination perhaps of negative events in the external environment.

Now let me cover the last one off first. Clearly one can’t keep blaming the external environment. I recognise that shareholders expect CEOs to navigate through, or fly around severe storms without damaging the company. However, some external events have hurt our company at a time we’ve been going through significant change. And if you’ll allow me to continue with the flying analogy for a moment, we’ve hit quite a few bumps when we were already flying at low altitude.

But I fully recognise there are some key issues that we need to improve. Most fundamentally, of course, we need to grow our earnings and our return on assets needs to improve, particularly the earnings from our investment, significant investment, in explosives needs to improve. I believe once we demonstrate this, our share price and total shareholder returns will start to reflect that.

So let’s look at the strategy and our performance and what has gone well and what’s not and how we intend to address the areas of under-performance.

In late 1997, we reviewed our entire portfolio. We spent considerable time looking at every one of our businesses and their degree of sustainable competitive advantage. We also spent some time reflecting whether a company that had high market shares of the markets we were in, that had almost all its sales within Australia and New Zealand, one per cent of the world’s market, was a sustainable formula going forward.

Some people have said, ‘well, why did you have to change? This was a pretty successful company before you came along, Phil, what’s all this change about?’

Well, the external world around us had changed significantly, not just before I came to the CEO role, but over the decade before that, which had seen tariffs significantly fall, trends to globalisation were occurring everywhere, the drive by ourselves and our customers to achieve internationally competitive performance or get out, was everywhere.

And we had a desire to simplify the company, to lower our costs, to make ourselves more agile, and also to make ourselves more understandable.

Our review suggested that some businesses which historically had been good performers were simply not going to be such good performers in the future. And some businesses, we decided, were worth more to others than they were worth to us. We weren’t the best parents for them in the long term. In some cases, we had under-performing businesses that we simply had to fix, close or sell.

The good news is that there were four businesses where we felt we did genuinely have long term sustainable competitive advantage, where we had growing and healthy customers, where we had leading technology, we had strong market positions, a history of good performance and the opportunity to grow over the long term.

And these businesses are our mining services, or commercial explosives business, our agricultural chemicals business, our consumer products business and our chemicals business.

And the choice of these four businesses as our core platforms wasn’t that they represented a uniquely synergistic combination, although there are some common issues and common skills that run across all four. But the most important factor in selecting these four businesses was that they were all good businesses that we were convinced we had the skills to make even better businesses.

Now in terms of the divestments of the non-core businesses, we have sold 14 businesses over the last four years and received returns of 1.1 billion dollars. It’s interesting to reflect that that is around 1.8 times the book values of the businesses we’ve sold. And I think I’ve told you we sold the businesses that we didn’t think were going to be the best businesses for us in the long term. It’s interesting to compare that number with our current share price, which reflects a net tangible asset backing of 1.1 times.

Now the reshaping of Orica is largely complete, apart from the plastics businesses.

We chose to improve those first by forming two significant joint ventures and we’re still to divest our holdings in those and I’ll return to that in a little later on.

But for each of our four core businesses, I’d now like to look at the rationale behind our belief in the business and our chosen strategy and where we’re going from here.

First of all, let me look at the mining services group. The rationale for us remaining in this business was that we’d had very positive experience in Australia servicing large innovative and demanding customers in the mining industry. We’d experienced double digit returns on sales, high returns on net assets and positive growth.

Interestingly, ICI plc, in the early 1990s decided to get out of their Asian explosives business because they decided they were basket cases and in a move they subsequently regretted, they let us take them over.

We found that by injecting our model of how to make a modern explosives business work and injecting our technology, we rapidly converted those into double digit ROS businesses, with growing market shares and good long term prospects. Our technology genuinely stacked up as being internationally competitive.

As we reviewed our strategy in 1997, it was absolutely clear that the trend of our customer base, the international mining houses, was going to be for continued consolidation and globalisation and the events of the last 48 hours, ie BHP Billiton, is another trend in that direction.

So we decided we needed to become international and, after looking at the options, we decided to acquire the remaining ICI Explosives business outside Australia and Asia. It was a business that we knew well. It was a business that we knew wasn’t a great business outside Australia and Asia. But we thought it had real prospects.

Now many people have said, ‘well, why do you think explosives is going to be a good business, Phil, outside Australia and Asia? It hasn’t actually been proven to be a great business’.

I place great store in Michael Porter’s competitive strategy work and the analysis of competitive dynamics, The Five Forces.

The negatives about the explosives business, on that analysis, would be this is an overall world slow growth market, growing probably at world GDP, no more. And, of course, we’re seeing signs of increasing customer power. At the small end of town, in the explosives business there are only moderate barriers to entry.

But those negative forces are countered by some significant positive ones. At the largest end of the customer base, barriers to entry are quite significant. For example Safety, health and environmental issues are stay in business issues when you own a large mine or quarry.

First of all if you don’t get explosives, you don’t run. Vibration, dust or fumes can shut you down, or cancel your licence. And big customers are much more demanding at the technology end generally, so require a fairly significant investment in R&D and also physical assets.

Long term contracts often apply in the explosives business, something that can be an advantage and as I will return to in a moment, a disadvantage. But it generally inhibits switching, indeed, often at remote sites where we have explosives facilities, we have assets on the ground and sometimes life of mine type contracts.

Importantly, in explosives there is a high level of invention and intellectual property associated with these, both in the products and the services and there is real leverage, in the extent to which explosives can help a customer’s overall efficiency.

The direct cost of explosives normally works out to be around five per cent of a miner’s purchased in costs; not insignificant but not huge.

But the impact that explosives have if used properly, and it’s worth reminding yourself constantly that explosives are the cheapest form of energy a mine ever uses. If used efficiently, explosives have an impact on something like 40 per cent of a mine’s total costs, whether it’s in removal of overburden, whether it’s in digging the resultant ore, whether it’s avoiding dilution, whether it’s in transporting the ore, whether it’s in crushing or grinding the ore.

So there’s significant leverage where explosives are used with the right technology and used effectively, on a miner’s total costs.

There are substitutes of course, but there aren’t any on the radar screen that look threatening to major mining operations.

And I guess the final point about the world explosives market is that there is the potential of a fairly attractive market structure. This slide shows you the market as it is today and there are really only two global players in explosives.

Orica is the clear leader and a company called Dyno Nobel is the number two, the only other global player. All the rest are regional and, as you can see, are considerably smaller.

Out of interest, Dyno Nobel have recently been acquired by a private equity investor Industrie Kapital, who don’t have the same history that Warren Buffett does, but their returns over the last 10 years have been every bit as good as his. It’s interesting to reflect that they thought explosives was worth being in too.

So what have we done in the last three years since we acquired the international explosives business and what’s gone well? As I said before, Orica is now the clear number one in the world and we operate in all the world’s largest markets, except for Africa.

We have the strongest technical base and we’re the leading innovator in blasting technology.

North America has been our first, and still is our first priority. Addressing the under-performance in the USA is a critical issue for us. We’ve done a huge amount of restructuring. We’ve closed two ammonium nitrate plants, a critical raw material. We’ve expanded our largest plant in Canada twice and purchased two others, all of which are designed to improve our cost position on that critical material.

We’ve relocated our North American technical centres and commercial centres and consolidated those to take out costs. We’re now headquartered in Denver. We’ve formed some critical joint ventures in the distribution end. We’ve won significant increases in market share and we’ve injected some new and high quality people into this business.

Outside North America, we’ve also made a number of important acquisitions, formed some key joint ventures and made some good new investments.

In Latin America, a business which we felt had significant promise but was under-performing in its period with ICI plc, we’ve converted that into a business making very respectable returns, which is growing nicely.

We’ve also recently launched electronic detonators we’ve brandnamed i-kon, which would probably be the biggest single breakthrough in explosives technology that’s been made in the last 10 years.

Conventional delay detonators use pyrotechnic delay elements which have an accuracy of at best something like plus or minus 20 per cent. Electronic detonators would have accuracies of plus or minus .1 or .01 per cent. And these yield the advantage of being able to really efficiently use the energy of an explosion and get the best possible result.

It sounds easy, but technologically it’s been extremely difficult for the industry to develop these and we believe we’ve got a leading position here.

We’ve also recently completed an acquisition in Germany called Dynamit Nobel and this gives us a base of a highly automated manufacturing facility for detonators, which we believe will allow us real opportunities for getting a much better cost position and a global sourcing position for those products.

Now profits and margins have grown each year since we acquired the international explosives business. That’s the good news. The bad news is that they haven’t grown nearly fast enough and are not yet adequately rewarding the investment we have made in that business.

And this year our profit growth in explosives will stall. Why? You might ask. Well, I referred earlier to significant issues opposite long term contracts. In North America, some of you may be aware that gas prices, gas is a feed stock into ammonia and ammonium nitrate, quadrupled from their long term levels last year and have fallen back now to twice their long term level.

When you’re buying ammonia, which is the feed stock we use, the cost of which is based on the cost of natural gas, it’s extremely painful to be selling against fixed price long term contracts for ammonium nitrate.

You might ask the obvious question, ‘well, why haven’t we hedged our position here?’ and the answer is that it’s very difficult to hedge a position in ammonia, and the correlation between ammonia prices and gas prices is a loose one at best.

The right long term position here is that we will incorporate, and we aim to incorporate in North America, as we have in other parts of the world, long term rise and fall clauses in our contracts with our customers.

In Australia and Asia, we’ve also had a share of difficulty. Many of you will know that our competitors built a new ammonium nitrate capacity on the east coast of Australia and we’ve had an overhang of capacity that’s affected prices on the east coast for some time.

This is the first full year of operation of that plant, so we’re about to go through, what I anticipate will be the worst of our exposure to that problem and, indeed, there’s good evidence that there’s growth in the market that will absorb that excess capacity over the next year or so.

We’re also experiencing this year the first full year of operation of our new investment in China and, like many investments in China, it will take time for us to turn that to a position of profits. We’re very optimistic we will do that and, indeed, we’re not dependent totally on the local Chinese market for revenues and profit. We see this as a very important export source for detonators from our site at Weihei.

Nevertheless, that’s another reason why this year our profit growth is going to stall. And we recognise that this is not a situation that gives investors much comfort, given the amount of cash we’ve put into explosives.

The really major issue in this business is North America. This is the biggest market that we’re exposed to. It’s where we’ve made a very significant investment and where we genuinely believe we have the capacity to capture a greater share of the value that we create for customers through our technology.

But the USA explosives market has over time become very commoditised. Customers have not been used to buying value-added services and appreciating the benefits of the technology we add. Elsewhere in the world, we’re confident that we are capturing a share of benefit from that technology. In the USA, we’re still to prove that.

Now I’m confident in explosives we are on the right track. I always said when we bought the international explosives business that it would take time to turn it into a good business, I said at least five years.

We’ve hit a few bumps on the way and we’ve got lots to do, but I’m absolutely convinced we know what needs to be done, we have the right strategies, we have the right people and skills to eventually create a terrific international business, which fundamentally generates value not through selling commodity chemicals but by selling clever technology, innovation and service.

Now let me turn to agricultural chemicals. The rationale for being in agricultural chemicals is that Australia has always been a highly efficient producer of agricultural products. There’s been a growing demand for nitrogenous fertilisers, particularly in Australia, and Incitec, our subsidiary company, is extremely well positioned in this regard.

We are the sole manufacturer of urea in Australia. We have strong and growing market shares and, indeed, we are the largest supplier of agricultural inputs in Australia. We’re national in our crop protection business and regional, as this slide shows, in the fertiliser business.

This business has had a track record of quite good returns, albeit they’re sometimes affected by the weather, but over the long term this has been a good business.

But what have we done to improve and grow this business? First of all, we have made significant improvements to logistics. We move 1.5 million tonnes of fertilisers around, and taking even a dollar a tonne off the cost of doing that's important. We've also upgraded product quality significantly.

We've moved from prilled to granulated urea and to superphosphate with much improved transport and handling properties. We've built on the unique strengths of products like Big N and Nutrient Advantage. And in technical innovation we have some great products. Granulock, is a tailored high analysis fertiliser, not reliant on blends but locked in granules. And we have great technology in our crop care business that's world leading, in water dispersible granules.

Some of you would be aware that in the past we've had our share of problems due to manufacturing issues in this business, and big continuous plants can bite you badly if they don't perform.

We've spent a lot of time over the last few years to try to get this right.

I'm delighted to point at the most recent turnaround we've had - you turnaround big plants like this once every four years or so and they're a big effort to do.

We've spent 35 million dollars at our Kooragang Island site with a turnaround that lasted 28 days, involved 150,000 hours of contract labour. That plant came back on stream on time, below cost, and is running above flow sheet rates now.

Furthermore, during that whole period of time - which you can imagines pretty frenetic activity - we did not have a single injury to one contractor or employee. I think our best ever shutdown.

But what still needs fixing and how are we going to do it?

Well, as you'd see from this slide, the Australian fertiliser business grew up in a very regionalised manner. And if you were starting again you wouldn't recreate it this way. There are opportunities for industry rationalisation which will improve the economics and efficiency of this business. And you shouldn't assume that we're being idle or inactive in this area, even though we haven't announced any specific plans we have in this direction.

But you should assume we're actively thinking about this and have some ideas which we think will yield a good result.

We also in this business would still one day like to build a world-scale modern urea facility based on Australia's gas.

It's a logical thing to do. Rather than export gas and import urea you think you might turn gas into urea domestically. There's an opportunity to do that.

And in this business we constantly fight the challenge of managing our working capital better. As you can imagine, demand for Ag products is quite often seasonally affected and forecasting, with long lead times of imported products, is an absolutely critical issue in terms of managing working capital.

To summarise the agricultural business, we are a key player, the largest player in the agricultural input market, and we think we have real opportunities to improve and grow our position.

In consumer products our rationale for this business is pretty straightforward. We have the best brands, we have strong market shares, we've got world-class technology, we've got excellent customer relationships, and this business has always had a great track record of performance.

What are we doing to improve this business? Well, first of all we've invested significantly to improve our manufacturing and our logistics position in our centralised manufacturing facility in Brisbane.

We've continued with excellent levels of customer satisfaction. Each year the hardware industry runs `supplier of the year' awards. Dulux and Selleys would have won more ‘supplier of the year awards’ from their customers than the total won by any other supplier to the hardware chain.

We've also got, I think, demonstrably leading technology in this area. Dulux 101 Wash and Wear and Berger Breathe-Easy are two examples of products where we get constant inquiries from overseas paint manufacturers to see if they can licence that technology.

We've also continued to invest in technology, just opening a brand new R & D centre at Clayton for our consumer products business.

In e-commerce we've not been idle. Dulux have launched DuluxTradeOnline, an e-commerce shop front which allows our customers in the trade paint area to access their accounts, to order product from us, and to improve efficiencies overall.

And we just released a new colour system in the Dulux range which we think will be very satisfying for our customers.

Well, what are the challenges going forward in this business? First and foremost, I guess immediately in one's mind is the fact that the building downturn is having its influence on this business, particularly and significantly in the trade business.

And the trade business is a business that we've got the spotlight on because we're not satisfied that returns in the trade business are as rewarding as they should be - certainly not as rewarding as the retail side of the business.

We've also got a challenge to pass on the cost increases that we're incurring through a lower Australian dollar. Many of the raw materials in this business are imported.

I guess most importantly the issue of growth comes back when you talk about consumer products. I mean, there are two easy ways of destroying shareholder value, and one is to grow an underperforming business and the other is not to grow a well-performing business.

Now, over the last five years or so we have grown the consumer products business quite nicely by bolt-ons in the Australian environment. Extensions such as wood care, the Rota Cota brush and accessory business, the car care market that Selleys are in, are all examples of where we've grown our position.

But we've become convinced, as we've analysed this fairly extensively, that our skills and technology in this business are genuinely internationally competitive, and indeed many of them we think are transferable.

Although we have nothing on the immediate horizon, I don't rule out one day looking to expand this business more internationally.

So, in summary, this is one of the top branded consumer products businesses in Australia and it does have opportunities for further growth.

Finally let me turn finally to chemicals. The rationale for the chemicals business is that we have extremely strong market positions, and a number of what you'd call privileged assets - these are plants or import tanks in the right locations. We also have a number of important strategic supplier partnerships, some very innovative technology in particularly niches and, importantly, we have developed a method of adding value to our customers through service and application technology.

This business has had an excellent track record of performance and indeed over the last three or four years has continued to improve every year. Right now, of course, it too is experiencing some of the impacts of the building and construction downturn, although they're more muted in chemicals than they are in some of our other businesses.

Some of you may be aware that we have brand new technology in the area of water treatment, and magnetic ion exchange technology, which originated in CSIRO and was jointly developed with them, called MIEX has the potential to be a world-leading product.

We're about to trial this product, in new plants being built in South Australia and Western Australia and, once we're satisfied the technology performs in the field as well as it does in the labs, we will move to a world stage in the exploitation of this technology. There are significant opportunities in the USA.

We continue to add value in this business through customer partnerships and through innovation in product and service. This business too has a leading edge e-commerce shop front which allows our customers to interact with us directly, and that shop front is interfaced directly into our SAP computer system that controls all our business systems.

There are significant growth opportunities in the chemicals business. Right now, we're spending a significant amount of money - 150 million dollars in total - on two new chlorine plants which have the prospect of significantly improving our cost base.

They're based around the latest technology, they're highly efficient, they're safe and they have markedly improved environmental performance.

Chlorine, of course, as you know, is an essential product that will continue to be used for water treatment.

It's a real frustration to us that at the moment industrial relations around the Victoria plant at Laverton are delaying the completion of that plant, which should have been completed by August last year. Its completion is delayed by at least nine months. And it's not been delayed by strikes but by ongoing interruptions, demarcations and generally unproductive behaviour to prolong the job.

We're a company that tries hard to work constructively with unions. We're not a union-bashing organisation. And in this case, of course, it's not our employees directly but contractors' employees and we've tried to work hard with the contractors, with the unions, with the State Government, with the Trades Hall. We've been to conciliation, we've tried virtually everything.

And this is a real cost to us and to our shareholders. And it's perhaps on the one hand understandable, that in this environment of a downturn in construction generally, that employees might attempt to prolong a job that they see is a good job and a safe job. But I don't believe it's smart or constructive.

We and others will invest where we can be confident of a fair, mutually beneficial and internationally competitive relationship with our employees, both direct and indirect.

And I believe unions should be helping to work with those who want to invest, to create more wealth and more jobs. The sort of behaviour we're experiencing at the moment in Victoria has the opposite effect and it is a deterrent to future investments by us and probably by others.

Now, let me summarise the chemicals business. This has a history of generating real value from in many cases, pretty basic chemicals that might not sound exciting. But we've enhanced our package by excellent logistics, clever technology around service, and application, and growth is still possible.

Now, I referred to the plastics business and I said that this was non-core but we had decided to create value first by forming some joint ventures. We do have a desire to exit these businesses and we recognise that shareholders are impatient to see progress.

In the case of AVC we will exit as soon as we reasonably can, once we get fair value that we believe is associated with that business. In the case of Qenos, we have agree with our joint venture partners that we would not exit this business earlier than mid next year.

The issues to be resolved in these businesses at the moment are - particularly in the Qenos business - further synergy benefits and efficiency improvements. And, in particular, the productivity of our operations at Altona. Many of you would be aware that we've just gone through a four-month strike at Altona.

Again, this is a bit of a case of unions and employees needing to recognise that it's not us who determines what's a world competitive level of performance. Australians have a choice. We can compete in these sorts of businesses or we can get out. But we know it's possible to compete.

Benchmarking internationally suggests there's a long way to go at Altona, and you don't have to look too far to see where it's a lot better.

Our Botany site has significantly better productivity than the Altona site. We're determined to work with our employees to actually achieve world competitive performance at Altona.

Of course this business also needs to ride through the current building and construction downturn.

In summary, through these joint ventures we have significantly rationalised the Australian plastics industry and are the sole manufacturers of PVC and polyethylene in Australia. Through this rationalisation we now have the cost base which would allow us to survive and indeed prosper with these businesses. But we do not intend to be the long-term owners of them. They belong to someone else who sees this as their core business.

So let me summarise the Orica story overall. We clearly recognise that there are issues that need to be resolved and fixed and we do have actions in place to address them. We've already made some important changes as a result of our performance and the external conditions.

And fundamentally it comes back to earnings and earnings growth. In the short term the earnings gap is mainly in the explosives business - particularly North America. And in the longer term we recognise our investors are looking for evidence of, and a shared understanding of, where our future earnings growth will come from. It's that that will eventually improve our share price and our total shareholder returns.

As a footnote, I should say in terms of management alignment that my and all the senior management teams' long-term incentives are only paid when Orica performs above the median of the ASX 100 in terms of total shareholder returns. And we don't capture the full value of those benefits until we're in a top quartile position - one we've been in before.

I'd like to finally show you a graph of the core businesses' performance in terms of earnings. This is an important graph because it shows that the four core businesses over a considerable length of time have shown quite steady - albeit not fast enough - but quite steady profitable growth. It's partly that reason that led us to conclude these core businesses will represent a much less volatile and much more reliable stream of earnings.

You can see the volatility in the total performance of the company that froth at the top - which sometimes gives us great joy and sometimes gives us despair - is one of the reasons we want to exit from the non-core businesses.

So our challenge is to complete divestment of the non-core businesses and accelerate the profitable growth in the core. I do believe that our strategy is correct, but it takes time to build a great business. And I don't minimise the task ahead. I acknowledge we've still got lots to do, but I also should point to some of the things that we've done pretty effectively.

We've made, I think, significant progress in reshaping, rebuilding and refocussing and simplifying the business. Massive changes have taken place over a comparatively short period of time.

We've made very large cost reductions, we have a shared services platform right across our Australian businesses for all functional support, and we've got an IT platform and an e-commerce base that I believe is close to leading edge.

Our safety performance - a critical issue in the chemical industry - is exemplary by Australian standards and it's pretty good by world standards. We can make it better.

And invention and R & D are alive and well in Orica. I've mentioned some of the things that we're particularly proud of recently.

And lastly I'd point to the fact that this is a company this has always prided itself on a sense of openness, on old-fashioned values of honesty and integrity. These have served us well in the past and I believe will serve us well in the future.

So my belief is that our core business can deliver excellent returns, and at present even through we're going through tough times, my assertion is we've done that before and over the long term we have delivered superior value. I'm confident we can do it again in the future.