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Bumper Harvest On The Table For Graincorp

Australia | Sep 09 2020

This story features GRAINCORP LIMITED, and other companies. For more info SHARE ANALYSIS: GNC

ABARES has upgraded its forecasts for the Australian east coast winter crop, which points to a more robust outlook for grain handler and processor Graincorp.

-Upside earnings potential beyond a 24mt winter harvest
-Graincorp likely to be loss-making in second half of FY20
-Strong rise in exportable surplus likely

 

By Eva Brocklehurst

After some savage weather conditions over the past year, grain handler Graincorp ((GNC)) is facing a much more pleasant outlook and brokers are counting the beans.

Official agricultural forecaster, ABARES, has upgraded its east coast winter crop outlook to 24.4mt. This is an upward revision of 13% on the initial estimate in June and represents the largest crop since the 2016/17 season.

A significant turnaround in the amount of rainfall received in south-eastern Australia at the start of 2020 has contributed to favourable seasonal conditions. The size of the crop will not be known until harvesting in November-December, and Morgans points out rainfall at harvest could negatively impact quality.

There is also potential for the first "decent" summer crop in five years, the broker notes, as the first forecast for the 2020/21 summer crop is 3.5mt, up 290%. Summer harvests occur between February and June.

Moreover, a larger canola crop, where production is forecast to rise 47%, is a positive for Graincorp's processing business. Greater volume should improve the crush margins, Morgans notes. That said, while Graincorp will incur a lower price for the canola seed and reduced freight costs, its end-sale prices for meal and oils are currently unknown and will be determined by the international market.

Goldman Sachs reduces forecasts for marketing operating earnings (EBITDA) in FY21 by -7%, amid trade disruptions, and allowing for lower crush margin assumptions.

Morgans also points out that in FY21 the processing business will have a difficult comparable to cycle as operating conditions were ideal in FY20.

The company has not provided earnings guidance for FY20 and the broker highlights that agribusiness earnings and tonnage are seasonally skewed to the first half. Morgans forecasts Graincorp will be loss-making in the second half and will be retaining a modest net debt position. Graincorp will report its FY20 results on November 12.

Upside?

Macquarie considers there is further upside to ABARE's winter crop estimate, with its analysis pointing to the potential for 25.6-27.3mt by June next year. UBS highlights a stronger earnings leverage that exists for a crop that is over 24mt as Graincorp's derivative payment is maximised at this level.

Graincorp received a payment of $58m in FY20, reflecting another below-average winter crop. The company will have to pay its insurer $76m gross in FY21 under the crop production contract based on this current estimate.

In a scenario where the FY21 crop is similar to the FY17 "bumper crop" of around 28mt, UBS estimates an operating earnings potential for the agribusiness segment of $190m. In turn, this implies a valuation at $6.40 per share compared with the UBS target of $4.50.

A strong crop in FY21 is also expected to support earnings growth into FY22, assuming this is, at the least, a normal cropping year. UBS notes a supportive balance sheet, with options through a minority interest in United Malt ((UMG)).

Goldman Sachs suspects the bulk of upgraded harvest expectations will be offset by the Graincorp's crop derivative contract although the strong harvest should improve the company's position following the drought.

Exports

Macquarie assesses there will be 7.8mt of exports, assuming Graincorp captures 75% of the export market. This exportable surplus compares with virtually no exports in FY19 and FY20. This is significant, as Graincorp earns higher margins on exports. However, the company will also need to replenish the domestic market, following three years of drought.

Moreover, Morgans points out the company's grain marketing operations are now smaller since the de-merger of the malt business and, following more prudent risk management policies, i.e. the derivative instrument, there is not the material upside that once occurred with bumper crops.

The derivative protects shareholders during poor seasons and reduces some of the upside in good seasons. Morgans calculates, looking at 23 years of data, if the derivative were in place it would have been more dilutive to earnings than has been the case.

While yet to comment on ABARE's latest forecast, Credit Suisse upgraded its winter crop estimates earlier this month to 25mt and suspects the market may be underestimating the size of the winter crop, along with Graincorp's leverage to incremental export volumes.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, acknowledges it missed the stock's recent rally but retains a Neutral rating with a $4.66 target. The database has three Buy ratings and one Hold (Morgans). The consensus target is $4.59, signalling 4.4% upside to the last share price.

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