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Late Flourish, But Outlook Pales For Graincorp

Australia | Sep 10 2018

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

The severe drought on Australia's east coast augurs poorly for Graincorp over FY19 but the company has surprised brokers with an upgrade to its FY18 earnings guidance.

-Most of the FY18 upgrade attributable to the marketing business
-Integration of logistics and trading a structural change that should deliver benefits over the long-term
-Poor east coast crop still likely to keep expectations in check

 

By Eva Brocklehurst

Surprisingly, Graincorp ((GNC)) is posting a strong finish to FY18 but, unsurprisingly, has reiterated a poor outlook for FY19 grains because of the severity of the drought on Australia's east coast.

The company has increased its FY18 operating earnings (EBITDA) forecasts and now expects $255-270m, a 1.9-6.3% upgrade. Malt was strong in the second half, and the contribution from the new Pocatello plant in Idaho and high levels of utilisation helped lift guidance.

There are also tailwinds from the craft beer market. The company's edible oil storage terminals performed well following strong customer demand. This strength is offset by lower crushing margins because of weakness in canola.

Since the company's May result, crop conditions have deteriorated substantially in eastern Australia. Graincorp expects a significant decline in grain production and its footprint is skewed to areas where drought is at its worst.

The company has to deal with an east coast crop that is down -15% year-on-year, although several brokers believe the poor crop is priced in to the stock. The drought warning has been occurring for some time now, Credit Suisse points out, and lower volumes should now be factored in, although acknowledges market expectations are likely to be kept in check.

Deutsche Bank agrees the poor FY19 crop is factored in and considers the improved guidance for FY18 a positive, as it provides evidence Graincorp is delivering on its efficiency and integration benefits. Most of the FY18 upgrade is attributable to the marketing business, Morgans suggests, while a better-than-expected result from malt assisted. The company has also benefited from a lower Australian dollar.

Further Downgrade To FY19?

However, Morgans suspects the share price is yet to fully capture the severity of the earnings downgrades required in FY19. The broker reduces FY19 operating earnings and net profit forecasts by -9.5% and -35.6% respectively. The greater revision at the profit level reflects the operating de-leveraging caused by the company's high fixed cost base.

In FY20 Morgans assumes an average season, but expects this particular year to be affected by below-average carry-over grain because of the small crop in FY19. Therefore, the next opportunity from which the company will obtain a benefit if there is an average season is not until FY21. Morgans would reduce the material discount embedded in its price target if seasonal conditions improve.

Bell Potter also expects that export opportunities will be limited in FY19 and this will affect the company's ability to absorb take-or-pay rail contracts and fixed costs within ports.

Following the update the broker upwardly revises FY18 net profit forecasts by 16% and downgrades FY19 by -32%. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has an unchanged Sell rating and $7.15 target. Bell Potter also does not envisage a normalised earnings base until FY21.

Non-Grains Business

Still, Macquarie notes management remains disciplined and committed to keeping cash flow positive even in a low crop year. The broker has explored the potential for asset sales and believes the edible oil terminals are the most saleable, although acknowledges these processes do not move quickly.

Macquarie looks favourably upon the growing contribution from the non-grains business as earnings volatility would reduce over the long run.

Over the long-term the integration of logistics and trading is a more fundamental structural change that should result in the network capacity being reduced to a level more in line with trading capability, Credit Suisse asserts, as the company removes sub-optimal sites and increases utilisation overall.

Meanwhile commissioning of the crusher expansion has started. Crush margins are expected to be lower in FY18 because of tight canola supply. The broker notes options for port rationalisation are also present and the company appears to be offering some aggressive discounts on storage to get grain into the system.

UBS maintains a Neutral rating on valuation grounds yet is encouraged by the underlying improvements to processing earnings. Assuming a return to normal cropping conditions in FY20 the broker believes the company could also benefit from re-negotiated rail contracts, strong demand from malt and a full contribution from the expansion of the oil crush at Numurkah. UBS believes the balance sheet can withstand the poor upcoming crop.

FNArena's database shows two Buy ratings and three Hold. The consensus target is $8.47, suggesting 8.1% upside to the last share price. Targets range from $7.22 (Morgans) to $9.20 (Deutsche Bank).

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