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Date : 14/12/2022

Graincorp

ASX :

GNC

Market Cap : $1.79 Billion

Dividend Per Share : $0.54

Dividend Yield : 6.73 %

Buy

52 Week Range : $6.89 - $10.86

Share Price : $8.02

Record FY22 results has yielded a bumper final dividend and special dividend. We retain a 'Buy'.

Company Analysis

The swings in wheat prices have been dictating the GrainCorp (ASX: GNC) share price trajectory. The Russia – Ukraine war severely impacted the wheat market. Demand sustained, and supply tightened, leading to sky-high prices during the second half of FY22. GrainCorp benefitted from this – upgrading its guidance and delivering a record FY22 result last month, with another special dividend up for grabs.


Source: Tradingview.com

Wheat Prices Normalised Despite the War

Due to weakness in wheat prices despite the ongoing war, GNC shares have traded flat since August. The supply-demand balance in the wheat market has constantly been evolving, which has affected prices:

  • Russia is flooding the market with wheat at low prices, and this has resulted in wheat prices going down globally.
  • The USA raised its outlook for global and domestic grain reserves and cut back its forecast for exports.
  • Crop output forecasts for Australia, Russia and Canada were also raised, leading to increased wheat supply.
  • On the demand side, the global economic slowdown is weighing on the price.

This mix of increased supply and decreased demand has seen wheat prices back down to levels seen in December 2021.

Challenges mean Wheat prices could rebound, again

However, this balance appears to be shaky. The bulk of the supply and volatility in the market is caused by Russia and Ukraine’s wheat exports. The harvest from Russia was the highest on record in the current year, extending competition into North America.

Wheat shipments from Ukraine continued after Russia agreed to extend the UN-brokered deal that guarantees a trade corridor for vessels carrying Ukrainian grain in the Black Sea for another four months, significantly reducing shortage concerns.

However, this deal remains on thin ice. We have already seen Russia use other commodities, such as Oil and Gas, to pressure Europe. Therefore, the wheat supply continues to be in danger of disruption as long as the war drags on. The longer the war drags on, the risk of shipping grain out of a war zone increases for freight and insurance companies.

Another uncertainty in the medium term is the evolving weather patterns that may affect crops in the Northern Hemisphere. High fertiliser prices have also contributed to higher input costs, which could impact supply if inflation remains sticky.

Amid record production, countries have stockpiled wheat in 2022, resulting in normalising demand. Any disruption to supply in 2023 will mean the balance is broken once again, and we could see higher prices at a time when stockpiling will begin again.


Source: Tradingeconomics.com

None of these concerns is being priced into wheat prices at current levels. Therefore, we think it’s a good time to top up holdings in GrainCorp when there is a price weakness at the commodity level. GrainCorp benefits from record cropping here in Australia due to the wet weather we have had and are forecasted to have. This means the company will sell more, resulting in elevated earnings and dividends, as we have already witnessed.

GrainCorp is also a leading diversified agribusiness, with an integrated operating model connecting growers to domestic and international consumers in over 50 countries. This puts them in a prime position to capitalise on the upside from exports.

Company Updates

Last month, GrainCorp announced its FY22 results, which came in as we expected. Revenues soared as export volumes surged, and profitability increased due to high prices seen throughout the first half of FY22. As expected, they announced another bumper final dividend, including a special dividend.

  • EBITDA: $703 million (FY21: $331 million)
  • NPAT: $380 million (FY21: $139 million)
  • A final ordinary dividend of 14cps, fully franked (FY21 final ordinary dividend 10cps); and
  • A final special dividend of 16cps, fully franked.

Additionally, the $50 million on-market share buyback announced in November 2021 was completed in July 2022. Therefore, $171 million in capital has been returned to shareholders through FY22 dividends and on-market share buyback.


Source: GNC

The Return on Invested Capital (ROIC) for FY22 was 28% – a sign that the company is making high-quality investments and reaping the rewards. We have mentioned in several reports how much we rate this metric as it symbolises efficient operations that translate into financials.

Agribusiness Performance was Stellar

EBITDA was up 127% to $624 million, reflecting an increase in total grain handled (41.1mmt vs 34.4mmt in FY21) and strong supply chain margins for grain exports. The increase in opening grain inventories, from 0.7mmt in FY21 to 4.3mmt in FY22, also contributed to higher storage and export volumes.

East Coast Australia (ECA) saw record production in FY22 with a significant increase in grain exports to 9.2mmt (FY21: 7.9mmt). There was a strong domestic outload at 6.4mmt as customers sought supply chain reliability.

The high grain carry-out supports FY23 storage and export volumes, and GNC is now investing in the ECA network to handle bumper crops.

GNC operated its ports at close to full capacity in FY22, exporting 9.2mmt of grain and oilseeds to international markets. GrainCorp’s International businesses also performed well, with good export margins from Western Australia.

GrainCorp is the number one Australian cereal and feed grains exporter to Vietnam, Japan, and China. GrainCorp’s Fats and Oils businesses also performed strongly amidst high global demand for renewable fuel feedstocks, including used cooking oil (UCO).

The Processing Segment was the weakest performer, with a 63% jump in Earnings

EBITDA was up 63% to $127 million due to strong oilseed crush margins and higher volumes driven by efficiency improvements at GrainCorp’s Numurkah crush plant in Victoria.

Crush margins were supported by strong demand for vegetable oils arising from global production challenges in canola and soybean, disruption of supply out of the Black Sea region, and growing markets in renewable fuel feedstocks.

GrainCorp’s Foods business delivered an 11% increase in sales volumes with continued strong demand for refined vegetable oils.


Source: GNC

Investment Thesis

So GrainCorp has basked under record cropping and amid high grain prices and delivered a record FY22 performance. The company continued to deliver on its strategy of strengthening its core businesses while pursuing targeted growth opportunities. During the year, GNC delivered tangible operational improvements across their Agribusiness and Processing supply chains.

They also completed the construction and commissioning of the Fraser Grains Terminal in Vancouver, B.C., through the GrainsConnect Canada (GCC) joint venture1, which supports the company’s ability to provide year-round supply to customers in Asia.

GNC also made good progress on growth initiatives and are known to be exploring several promising opportunities in the areas of alternative protein, AgTech, animal nutrition and agri-energy.

GNC’s Strategic priorities will Drive Shareholder Value

In March 2021, GNC announced a new round of operating initiatives to deliver an additional $40 million EBITDA per annum in the core businesses by 2023/24. These include expanding the bulk materials offering at GrainCorp ports, shifting processing towards higher value products, and implementing LEAN practices in Foods and Oilseeds. The company is well on track to deliver this uplift.

Through these initiatives and the Crop Production Contract, GNC has measures in place to support the base earnings of the business and provide cash flow support in drought years.

In addition to the core businesses, GNC is targeting new growth opportunities in areas where it can leverage its supply chain infrastructure and build on GrainCorp’s existing capabilities and its track record in research, development, and innovation. This approach will ensure a bang for their buck as far as investments are concerned and will help maintain a high ROIC.

As one of Australia’s leading suppliers of renewable fuel feedstocks – including UCO, tallow and canola oil – there are opportunities to expand the agri-energy business to take advantage of the growing global demand for these commodities in the production of biofuels. GNC is considering a range of options and is excited by the potential in this area.

AgTech

In May 2022, GNC launched GrainCorp Ventures, a corporate venture capital fund that will invest up to $30 million in AgTech start-up businesses over three years. The fund will focus on the areas of analytics and optimisation, smart supply chains, biotechnology, and sustainability/circular economy. The objective is to develop solutions to some of the industry’s fundamental challenges and support Australian agriculture’s long-term, sustainable growth. This is a proven strategy typically applied by the high-flying technology business in search of more innovation, and it’s good to see GrainCorp employ such strategies and look for businesses that can add synergy to their existing business.

Alternative protein

Another high-growth area, during the year, GNC announced a collaboration with CSIRO, Australia’s national science agency, and v2food, a leading plant-based food producer. The parties are currently working together on a research project in the fast-growing plant-based protein market and building Australian processing and manufacturing expertise to add more value to grains and oilseeds and reduce reliance on imported ingredients. The project has received $1.8 million in funding from the Australian Government’s Cooperative Research Centres Projects (CRC-P) Program to support this research.

Another Large East Coast Australia Crop Year Positions GrainCorp Positively

Commodity stocks are cyclical, yes. However, it is about understanding the cycle for each commodity. GrainCorp continues to operate in a La Nina period where wet weather will persist for another year on the East Coast of Australia.

This will be the third La Nina event in a row along the ECA, and GrainCorp is again gearing up for record production levels. These levels mean that GNC will have significant operating leverage, as it has already demonstrated in the past two financial years.

We are thus currently mid-cycle, and GrainCorp needs to just operate as it has been to reap the benefits and deliver high earnings and dividends.

Two Directors top-up Holdings

Two weeks ago, Directors Clive Stiff and Kathy Grigg added to their holdings by buying 10,000 and 6,000 shares at around $8.4 a share. The company is operating at a high capacity and is also expanding its capacity along the East Coast. While wheat prices have trended lower, they are by no means low at current levels.

Another huge crop year and two Directors buying shares are extremely positive signs for retail investors, which reassures our rationale.

GNC’s Balance Sheet has been Strengthened

The huge earnings coming through have meant that GrainCorp has gone from a core debt position to $177 million in core cash. Core cash represents the total cash that GNC has left following all costs, interest & tax, capital management, working capital requirements, and dividends & buybacks. This is a healthy position, especially considering where GNC was just a year ago.

The higher working capital and commodity inventory have meant that Net Debt remains above the longer-term year-end average that GNC maintains. As of the end of September, GNC had over $500 million in debt on its balance sheet. Of this debt, $150 million consists of Term Debt, which will not expire until 2025. This puts GNC in a safe and healthy position.

Outlook

Market consensus has downgraded GNC’s revenues and earnings for FY23 due to 2 reasons:

  • Record October rainfall and recent flooding in many regions of eastern Australia have caused significant damage and crop losses for growers in affected areas.
  • There is continued high rainfall forecasted in December & January, which may cause further damage and additional losses if crops cannot be harvested.

However, we believe that GNC’s revenues should be unaffected and come ahead of the consensus estimates. Near-record production in areas not flooded will offset the losses, and more importantly, GNC already has a high level of grain inventory in its network and a strong export program which they expect to continue throughout FY23.

According to the Australian Bureau of Agricultural and Resource Economics (ABARES), the value of Australian crop exports is also expected to increase to $46.7 billion in the 2022–23 financial year. This would be the highest on record, 18% above the 2021–22 total of $39.6 billion. This is due to elevated world prices combined with high volumes of production and exports – where GNC will play a critical role.

The Australian wheat export price (Australian Premium White) is forecast to increase by 11% in 2022–23, averaging $546 per tonne. World grain and oilseed prices are being supported by strong demand, persistent dryness in Argentina, the European Union and the United States, and uncertainty surrounding trade flows from the Black Sea region. Export prices for grains and oilseeds are likely to remain high for the remainder of 2022–23 but are expected to remain below the record highs reached in the first half of 2022.

The forecast chart also shows the cyclicality of GNC and the grain market. The third La Nina event in a row is massively boosting profitability and dividends, and it is expected to play out in FY23 too. Following this, markets have priced GNC to normalise its revenue and earnings as they revert towards the mean.

GrainCorp is well positioned for FY23, with the businesses performing well, a strong balance sheet and a pipeline of growth opportunities. The outlook for FY23 is much more robust than what the markets are estimating, which is why we think GNC will perform well and also pay healthy dividends.

The exceptionally strong margins achieved in the first half of FY22 moderated in the second half as expected, as supply from other grain-producing regions improved. We will likely see similar levels in 2023, barring any imbalances caused by factors we detailed earlier in this report. Global demand for Australian grain remains strong.

Oilseed crush margins are expected to remain favourable, and GNC is well positioned to operate its crushing facilities at high utilisation and continue to maximise this opportunity. While GNC did not provide guidance at this stage, they did, however, state that guidance will be issued at their AGM on 16 February 2023. We believe that is when the price will catch up to the value.

Our earlier report can be viewed by clicking here.

Recommendation

GrainCorp delivered stunning FY22 results, just as we expected – substantial earnings growth resulted in a bumper final dividend and special dividend. Effective growth and supply chain investments have led to GNC maintaining an ROIC of 28%

The GNC share price, however, has traded flat since wheat prices have come down from the March 2022 highs in the wake of a bleak global economic outlook and amid high supply. Challenges remain, particularly due to the ongoing war, which can result in the price spiking again in 2023.

GNC is again gearing up for record levels of cropping as the East Coast of Australia is set to go through another La Nina event, making it three in a row. Therefore, we once again forecast positive earnings and dividends in FY23. Directors topping up holdings reassures us in our rationale, and we retain our ‘Buy’ recommendation.

 

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