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Company: Graincorp

Stock code: GNC

Share Price: $7.78 (as at close Friday 28th October 2011)

Market Cap: $1,587,000,000

Dividend Yield: 4.2%

P/E ratio: 10.13

Broker Calls

RBS – BUY, Price Target $9.25

Citi – BUY

Deutsche – Hold

Morningstar – Hold

 

Chart: Share price over the year versus ASX200 (XJO)

Stock code: GNC

Charts: Graincorp Limited

More news: Graincorp Limited

Graincorp, a 95-year old Australian grain-handler, owns and manages a large amount of grain-handling infrastructure on the eastern coast, giving it significant market share in storage, handling and port elevation services. The biggest problem for GNC is seasonality – as is to be expected earnings are at the mercy of the weather gods. To combat this it has diversified into malt production, which helps the company lower earnings volatility as well as giving it room to grow.

Without rain, GNC is just like any agricultural stock – high ongoing fixed costs with earnings that can quickly run dry. This is precisely what happened in 2007 and 2008 when the share price more than halved as drought set in. However 2011 is shaping up as a bumper harvest year, with the company boosting storage capacity in Victoria by 670,000 tonnes to cater for what is shaping up to be a big Victorian harvest. And let’s not forget the takeover speculation swirling around the grain handler, with several analysts speculating that a bid is in the air (see ‘Takeover Target?’ section below).

Deutsche research analyst Dominic Rose is one such analyst who speculates that the company could be subject to a takeover bid as major global players look to Australia to chase scale, vertical integration and earnings diversification. Rose also believes that the outlook for the global agricultural sector is favourable, underpinned by growing food demand from emerging economies and supply constraints.

Description

Graincorp’s principal activities include receival, handling and storage of grain and other bulk commodities as an agent for marketing organisation, end users and growers; marketing of grain, wool and other bulk commodities, and the operation of grain pools; road and rail transport services for bulk commodities; provision of farm input products; provision of financial services, and flour milling and mixing services.

The company’s wholly owned subsidiaries include Graincorp Services Limited, Victorian Grain Services Pty Limited, Grainco Australia Pty Limited, Graincorp Warehouse Cashflow Pty Limited and Graincorp AG Finance Limited. It also has a 60% holding in the flour miller Allied Mills and recently acquired German malter GermanMalt (renamed Schill Malz, after the original owners) for 58 million euro.

GNC has largely grown via acquisition and currently boasts an enviable position in the eastern Australian grain market. It now has a global malt business as well, and as one of the largest commercial malt producers in the world it supplies some of the world’s leading brewers and distillers on long-term contracts. The strong Aussie does have an impact on earnings from the business, however the business continues to grow nonetheless.

Financials

Earnings have been driven by higher receivals, storage and export volumes, as well as higher Grain Marketing earnings. GNC has provided FY guidance for volume and earnings:

Volume guidance:
– Country receivals ~15.0mmt
– Grain exports 7.0?8.0mmt
– Malt sales 1.0?1.1mmt

Earnings guidance:
– EBITDA $310-340M
– NPAT $145-165M

Source: Graincorp Presentation ‘A Day At The Farm’, JP Morgan Conference

As you can see from the chart above, earnings for this year is set to far exceed previous years – in fact, this year GNC will report a higher NPAT than the previous four years put together.

In its half-yearly results presentation in May, GNC outlined the massive increase in revenue for this financial year. The charts below paint a nice picture – EBITDA, NPAT and operating cash flow are all up significantly.

Source: Graincorp Half Yearly Results Presentation

All segments of the business have contributed to the increase in earnings. Malt earnings are up 25%, Storage & Logistics and Grain Marketing are up 50% and Port earnings have doubled.

Source: Graincorp Half Year Earnings Report 2011

Wheat & barley prices

While this year’s bumper season is the driving force behind the huge increase in earnings, as well as acquisitions, stronger wheat and barley prices aren’t hurting the company either.

Over the past year wheat prices have increased slightly in Australian dollar terms.

Source: IMF

Meanwhile barley prices have increased by more than 15% in Australian dollar terms.

Source: IMF

Takeover target?

Just last year GNC opened discussions to merge with AWB to form a grains powerhouse in Australia. However after being trumped by Canadian fertiliser maker Agrium, which bid $1.2 billion for AWB, GrainCorp could itself be the next takeover target.

It’s impossible to accurately predict whether a company is set to be taken over by a rival, however often there is no shortage of speculation and chatter leading up to the event. In May this year, there was such intense media speculation that Canadian group Viterra was looking to launch a takeover bid for GNC that the company released this statement to the ASX:

‘GrainCorp is cognisant of its continuous disclosure obligations and has no information to convey to the market. Beyond this statement, GrainCorp does not comment on media speculation.’

Viterra also declined to comment on the matter, however its CEO Mayo Schmidt admitted that it planned to be a player in the consolidation of Australia’s grain industry. Viterra is already the dominant grain-handler in South Australia after taking over ABB Grain two years ago.

UBS analyst Tasneem Azim was quick to let clients know about the potential takeover of GNC after Schmidt’s comments. “A potential acquisition of Graincorp, we believe, is consistent with Viterra’s acquisitive growth strategy with several strategic merits,” he said in a client note. Nelson Mah from Northern Securities also believes that this is a distinct possibility. “In our view, GrainCorp is in play given its unsuccessful attempts to growth through acquisitions,” he wrote to clients. “Viterra could be a potential acquirer but there are several other global agriculture companies capable of acquiring GrainCorp.”

Mah pinpointed no less than six other potential suitors – CBH Group, the largest wheat exporter in Western Australia; Archer Daniels Midland; Bunge Limited; Singapore-based commodities trading firm the Noble Group; Gavilon LLC, which previously tried to acquire AWB Ltd.’s grain trading business; and Cargill Inc., which recently bought AWB’s grain handling business from Agrium.

Analysts’ views

Citi has a high risk buy on the grain handler and it has increased its outlook for crop tonnage this year, saying that there is material upside to its estimates. The broker sees recent share price weakness as a great opportunity to get on board.

Another broker that is very positive on Graincorp is RBS, which says that the company has a big year ahead. RBS has a $9.25 price target on GNC, and just like Citi it has lifted its forecasts leading up to November 24th’s release of grain harvest results. It has also lifted dividend estimates and believes that the shares will continue upward over the coming months.

‘This grain handler had been subjected to heavy selling over weather concerns,’ says Nicholas Brooks from RBS. ‘But well-timed rains in Queensland, New South Wales and Victoria are setting up what should be a record crop this year.’

Not all analysts are so bullish. Deutsche analyst Dominic Rose says that the stock is in line with their valuation and has a hold on GNC. According to Rose, GrainCorp offers investors non-GDP related exposure given its earnings are predominantly leveraged to east Australian grain harvest volumes and demand for malting barley which are both largely independent of economic growth.

“However, while the longer-term outlook for the sector appears favourable, we see shorter-term earnings growth challenges on the back of a record FY11 harvest,” Rose said. “GrainCorp is impacted by seasonal forces, which can create forward earnings uncertainty and volatility. Drought can also be a key risk to earnings, as evidenced in 2007 and 2008. With the FY12 harvest unlikely to match FY11, in our view earnings growth will be challenging.”

Although Rose doesn’t see the stock as a screaming buy, he does admit that GNC is a takeover target. ‘The Australian grain sector has corporate appeal following high levels of merger and acquisition activity in recent years as players chase scale, vertical integration and earnings diversification.’

Conclusion

There are two ways to look at GNC – as a going concern and as a potential takeover target. Should the latter come to pass the share price is sure to spike, however any investment in a company needs to be taken with more than a potential takeover in mind. The fact is, takeovers are rare and it is hardly the sole reason for investing in a company.

Takeovers aside, GNC is currently in a strong financial position following two capital raisings in 2009 and this year’s bumper crop. Also its entry into the malt business helps to smooth out earnings. However you can’t escape the fact that this is a cyclical business and investors need to take note that periods of drought place the balance sheet under intense pressure. An investment in GrainCorp is as much about forecasting the market as it is forecasting the weather.

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