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Morningstar | GrainCorp's Lifted Guidance Suggests Improvements During a Tough Year Will Reap Long-Term Rewards. See Updated Analyst Note from 05 Sep 2018

No-moat GrainCorp's improved outlook for fiscal 2018 tracks slightly ahead of our near-term expectations, but our valuation hinges on longer-term, midcycle assumptions rather than performance in this challenging year. Highlighting this, despite management raising EBITDA guidance to AUD 255-270 million, up from AUD 240-265 million previously, and NPAT guidance to AUD 60-75 million, an increase from the prior AUD 50-70 million, these metrics are still slated to fall more than 33% and 50%, respectively, versus fiscal 2017. Nonetheless, the enhanced viewpoint is in line with our thesis for improved internal operations, greater contribution from the solid North American malts business, and more-flexible operations in Australian grain storage and handling. We've raised our fiscal 2018 EBITDA forecast 3% to AUD 260 million and our NPAT projection 7% to AUD 62 million, but maintain our AUD 8.30 per share fair value estimate.

Our changes concentrate on GrainCorp's storage and logistics business. As we discussed in our note on Aug. 2, 2018, the Australian grain growing season is shaping up to be extremely poor--likely one of the worst in nearly a decade--given a lack of rain in key farming areas throughout the Eastern seaboard. With lower systemwide volumes, limited export opportunities, and a high degree of operating leverage, we had already expected this segment's profitability to suffer in fiscal 2018. But we've also previously noted reduced fixed costs and improved internal operations (including combining the marketing arm with the storage and logistics segment) should lead to greater EBITDA/tonne and stable market-share going forward. It seems the improvement is already starting to take hold, and we've lifted our near-term market share forecast to about 40% of the grain harvest from 35%, and our operating margin forecast for storage and logistics by one percentage point.

Our long-term outlook for this segment remains, however. Alongside a normalised weather environment, we expect continued fixed-asset reduction and better-structured rail haulage contracts past fiscal 2019 to drive consolidated storage, logistics, and marketing EBITDA margins to nearly 8%, from 2.5% in fiscal 2018 and roughly 7% in fiscal 2017.

We're also encouraged by further positive performance in GrainCorp's North-American-focused malt business. We continue to anticipate the secular growth of craft beer volumes in the U.S. will drive mid-single-digit revenue growth and EBITDA margins nearing 15% versus 14.3% in fiscal 2017, while revenue grows at a mid-single-digit pace. Management confirmed the segment is operating at a high utilisation rate, and with a noted strong second-half performance, we've lifted our near-term margin outlook slightly, to 14.5% from 14.3% previously. We expect this business will remain GrainCorp's largest in the long term, making up more than 46% of consolidated EBITDA in fiscal 2022 compared with about 40% for the storage, logistics, and marketing arm.