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Dry Season Pressuring Graincorp’s Outlook

Australia | Sep 13 2017

Following below-average winter rainfall, ABARES has revised its winter crop forecast and brokers evaluate the implications for Graincorp.

-Despite downgrades, potential still exists for a reasonable FY18 result
-Share price may not yet be fully reflecting the deteriorating conditions
-Smaller crop to result in increased competition for a smaller grain pool


By Eva Brocklehurst

Following below-average winter rainfall, ABARES has revised its winter crop forecast for wheat, barley, canola, sorghum and chickpeas. The prospect of a below-average crop has resulted in brokers reviewing the outlook for Graincorp ((GNC)).

The ABARES quarterly crop update may have been above many forecasts, because of a 16% upgrade to Victorian yield expectations, but in contrast, NSW and Queensland were below estimates, reinforcing suspicions of negligible grain exports from those states in 2018.

Credit Suisse, in recognising the tendency for crops to be downgraded as an average, or dry, season progresses, sets its Victorian forecast at a 50 percentile yield versus around 60 in the ABARES forecasts. The ABARES east coast crop forecast for 2017/18 is 18.7mt. This is down -6% on the June estimates.

Reflecting bearish expectations heading into the update from ABARES, the broker observes the stock market reacted quite favourably. Moreover, noting Graincorp is trading towards the lower end of its typical $8-10/share trading range and there little structural change to earnings, Credit Suisse suggests a near-term seasonal downgrade may present an opportunity.

Graincorp's market share in FY16, a similar sized crop year, was about 42%. In applying this to FY18 forecasts, Morgans calculates total grain receivables of 7.8mt, down from 13.7mt in FY17 and prior forecasts of 9.0mt. The broker hastens to highlight that this is not without risk, and the forecast is based on there being sufficient, and timely, spring rainfall across Australia's cropping regions.

While believing Graincorp remains on track to deliver FY17 earnings guidance, the broker reduces forecasts because of a slowing in fourth-quarter activity as, given concerns over the current crop, farmers have either decided to hold their stocks on-farm or sell into the domestic market to capture a premium price compared to that on offer in the export market.

Morgans downgrades FY18 forecasts to reflect the ABARES revisions and the impact of reduced grain volumes on the company's marketing businesses. The broker also revises down forecasts for oils & malt, to reflect higher electricity prices and an elevated Australian dollar. All up, FY18 net profit is forecast to be down -33.5%, at $100m.

Nevertheless, compared with the past when crop yields were below average, a large carry-in from the record 2016/17 crop, a contribution from the company's projects across oils & malt and a better fixed cost base suggests a reasonable result is still on the cards.

Morgans agrees the best time to buy Graincorp is during a poor season, in anticipation of improved returns, but considers the share price is not yet fully reflecting the deteriorating seasonal conditions. The broker would become a buyer of the stock under $8 and maintains a Hold rating at current levels.

Supply Chain

East coast grain markets are past peak capacity additions and likely to enter a period of capacity consolidation. Credit Suisse believes the company could, and should, be exploring options for closing its port at Newcastle and entering a capacity sharing arrangement with its competitor, thus increasing industry utilisation and providing a more transparent market valuation for port assets.

The broker acknowledges recent integration of the company's trading and logistics operations are consistent with operating a tighter/more integrated trading and supply chain, reducing surplus country storage capacity and improving return on assets.

Credit Suisse suspects, with planned expansionary capital expenditure being reduced from FY18, and a free cash flow yield forecast of 9.6% in FY17 and 10% in FY18, an increasing dividend pay-out is likely. The broker retains an Outperform rating.

Bell Potter rounds off the trifecta. The broker, not one of the eight monitored daily on the FNArena database, has a Sell rating and $7.73 target and believes the ABARES crop estimates continue to carry a downward bias into the December report.

Forecasts are adjusted to reflect a further reduction in FY18 crop receivables in the network and lower crush margins in the canola business, based on lower canola production forecasts and recent corrections in the Canadian crush margins.

Bell Potter also incorporates changes to Australian dollar assumptions in the malt business and makes a modest reduction in estimates of marketing returns, based on a smaller contestable crop, which limits marketing options and lifts competition. Typically, smaller crops result in increased competition for a smaller grain pool and this results in a contraction of returns from grain marketing.

FNArena's database shows two Buy ratings and three Hold ratings. The consensus target is $9.63, suggesting 18.6% upside to the last share price. The dividend yield on FY17 in FY18 forecasts is 3.9% and 3.7% respectively.

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