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Graincorp Outlook Improves With Diversity

Australia | Nov 17 2016

This story features GRAINCORP LIMITED. For more info SHARE ANALYSIS: GNC

Graincorp's earnings performance is expected to improve in FY17. That said, the degree of upside is unclear because of delays to harvests.

-Increased competition in storage and at ports may hurt volumes and margins
-Malt business impresses brokers and oils expected to grow in FY17
-ADM stake envisaged limiting upside until offloaded


By Eva Brocklehurst

A large east coast harvest is under way and an improved earnings performance is expected from Graincorp ((GNC)) in FY17. Yet the degree of upside is unclear because of the delay to harvests and the extent to which farmers may hold back their grain because of low prices. Increased competition is another factor that may hurt the company's volumes and margins. On this basis, Morgans, for one, believes consensus expectations are too high.

The company's FY16 results were at the upper end of Graincorp's guidance and, despite earnings growth, it was a subdued year for the company because of a below-average crop and tough operating conditions in the oils business. The highlight for brokers was the performance of the malt business. Marketing disappointed, as intense competition for grain in eastern Australia, a larger world crop and cheaper ocean freight reduced Australia's export competitiveness.

The company did not provide specific guidance but did mention that FY17 would be a strong year, as a result of an above average east coast grain crop. Morgans expects the marketing business to continue being impacted by competition and a global oversupply of grain. On the plus side, the company continues to target a more balanced portfolio, with one third of earnings coming from each of malt, oils and storage & logistics.

The broker highlights that growth projects and cost reductions should set up the company for a big FY18, assuming a normal season. While the outlook is much better for FY17, and FY18 should benefit growth projects and de-leveraging, Morgans is a happy holder of the stock, but notes ADM's holding continues to overhang, given that company has declared it is a seller of the stock. This 19.85% holding is likely to crimp some of the upside and the broker retains a Hold rating.

On a seasonal basis, Macquarie observes the storage & logistics business is looking for a strong year in FY17. Weather is the key factor over the next month with fine conditions required for crops after a wet start to the season. The harvest is expected to be approximately three weeks late and the yield and quality remain uncertain. Marketing once again disappointed the broker, given the less competitive Australian grain and an oversupplied global market, and no relief is expected in FY17.

Structural change has increased, with heightened competition, and this reduces the margin upside relative to the company's prior peak levels, Macquarie observes. On a more positive note, the broker flags the malt business, which is benefitting from strong craft beer and whiskey demand. After a challenging FY16 the oils business is expected to show positive growth in FY17.

UBS upgrades forecast by 3-12% based on the stronger performance in the malt division. Results may have been ahead of expectations but the broker considers FY16 was relatively weak overall. Pressure was again on display in the grain supply chain and trading business, which has been impacted by three consecutive below-average east coast crops and increased competition for the grain receivals and at port.

The company has spent $540m on targeting an after-tax return of over 12%. While this is difficult to judge because of new competition and different grain carry and receivable periods, UBS believes the company is around $88m behind in its returns objective in terms of earnings. That said, NSW and Victorian state governments have begun improving grain rail lines but these will not deliver meaningful benefits until FY18-19.

The broker expects Graincorp to lift its sustainable return on equity and deliver free cash flow from FY17 as its expenditure on growth tapers off. While delays to the harvests are likely, UBS still believes the company will increase its supply chain market share as more grain is exported.

Morgan Stanley is quite positive and now expects the FY17 east coast harvest to be 22mt, which would be the third largest in history. Its Overweight rating reflects expectations that the company is at the start of an inflection point in earnings.

The broker notes $300m in growth expenditure will come on line in FY17 and these assets could contribute $40m to earnings, representing 16% growth on FY16 alone. Morgan Stanley believes the market is only partly incorporating the upside from cost initiatives, improvement in free cash flow and harvest upgrades in its estimates, although concedes that a solid confirmation in FY17 is still required.

While Deutsche Bank considers the results positive and ahead of expectations, the stock is now trading at a 4% discount to its valuation and the rating is therefore downgraded to Hold from Buy. This broker also expects the stock to be constrained in the near time by the perceived overhang of the ADM shares.

Deutsche Bank highlights ongoing diversification benefits from growth in the malt division and a return to growth in storage & logistics. Despite the efforts to diversify the base in recent years, Goldman Sachs emphasises that earnings remain highly leveraged to east coast Australian grain volumes. The broker, not one of the eight monitored daily on the FNArena database, has a Neutral rating and $9.09 target.

Credit Suisse upgrades malt forecasts, expecting profitability to be sustained, as well as east coast crop forecasts, while downgrading marketing profitability. The broker observes capital expenditure on oils and malt appear to be achieving satisfactory returns.

Credit Suisse estimates the combined winter and summer crop at 22.5mt. The broker assumes that country receivable market share is stable at 47% but underlying market share is expected to fall because of the continuing development of on-farm storage. There will also be new port competition in FY17 from the Quattro facility at Port Kembla. That facility is likely to take around 500,000t of exports.

There are two Buy ratings and four Hold on the database. The consensus target price is $9.08, reflecting 6.8% upside to the last share price. Targets range from $8.70 (Morgans) to $9.75 (Morgan Stanley).

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