EUR 850.00 For Business Accounts Only

Morningstar | GrainCorp Eyeing Tough Conditions in FY19, but Remains Focused on Long Term; AUD 8.30 FVE Unchanged

No-moat GrainCorp’s fiscal 2018 results reflected tough grain conditions, but encouraging results in malts and oils. The firm saw its top line fall nearly 8% versus the previous corresponding period, or pcp, on the back of 15% drop in grains, while underlying EBITDA dropped an even greater 30% due to a high amount of fixed costs. Nonetheless, EBITDA of AUD 269 million and NPAT of AUD 71 million was at the top end of management’s recently raised guidance, and surpassed our forecasts of AUD 260 million and AUD 62 million, respectively. While we expect fiscal 2019 will remain difficult for grains, we’re encouraged by continued efforts to reduce costs, and expect further growth in malts and oils. We lower our near-term EBITDA forecasts, but maintain our long-term projections and AUD 8.30 fair value estimate. Shares screen as slightly undervalued.

Eastern Australian production is the key driver for the grain segment, which represented more than half of fiscal 2018 revenue, and drought conditions look to cause another 30% fall in grain volume for the 2018-19 growing period after the nearly 40% decline in 2017-18. Beyond lower throughput for GrainCorp’s assets, a reduced harvest also leads to smaller exports and more-limited marketing opportunities. As a result, we expect the segment’s revenue to fall 25% in fiscal 2019, after a 15% decline in the year reported. We also predict EBITDA margins will tighten to 2% from 3% in fiscal 2018, and nearly 8% in the bumper crop year of 2017.

But we’re encouraged by capital reduction in this business. GrainCorp has reduced its operating sites to 145, down from 160 last year, with more declines to come, and should enjoy improved rail haulage expenses as take-or-pay contracts (which are punitive in a low-volume environment) roll off in fiscal 2020. As the company takes out costs and fixed assets, but retains flexibility, we expect margins to rebound to higher than historical levels in a normal growing season.

GrainCorp’s malt and oil businesses, which together made up about 50% of revenue, but more than 75% of underlying profit in fiscal 2018, continued to enjoy solid growth and profitability improvement. We expect the segments to enjoy further secular top-line gains, from rising craft beer and whisky volumes in malts, and continued solid demand for bulk liquid storage and crushing demand in oils. And with a solid turnaround ongoing in oils, and new, high-margin capacity being added in malts to support rising Scotch whisky demand, we expect these segments to make up nearly two thirds of GrainCorp’s profit pool in five years, despite the improving margin profile of grains.

Importantly, GrainCorp’s balance sheet remained solid in the fiscal year. Despite the sharp decline in EBITDA, core debt (which excludes financing for commodities held in inventory) finished fiscal 2018 at a 2.12 multiple to EBITDA--up from 1.41 in fiscal 2017, but still well below fiscal 2016’s 2.86 and well within covenants, per management. Moreover, while higher net working capital led to the firm’s cash conversion cycle spiking to 75.6 days, from 54.7 in the pcp, we attribute this to the company choosing to carry some extra inventory to satisfy demand in a period of supply uncertainty. As such, we expect this to reverse in coming periods, freeing up capital in the process.