GrainCorp’s Resilience In A Trade War Backdrop

Small Caps | 10:30 AM

GrainCorp's first half FY25 earnings 'beat' was undermined by only a modest increase in guidance, due to elevated global grain supply. FY26, nevertheless, offers upside potential.

-GrainCorp's first half earnings well ahead of forecasts
-FY25 guidance upgrade nonetheless modest
-Elevated global supply pressuring margins
-FY26 seen offering upside potential

By Greg Peel

Agricultural business GrainCorp ((GNC)) posted first half FY25 (ending March) earnings well ahead of consensus forecasts, aided by a crop in Australia that was the third largest on record.

To achieve the 'beat', GrainCorp was assisted by earnings diversity across its businesses given elevated global supplies of wheat and oilseeds led to depressed margins for the company's traditional wheat export and canola crush segments, noting Australia's crop was once again bumper.

Despite weaker margins, GrainCorp managed to grow earnings by 23% year on year.

Outside of GrainCorp's Australian exposure established over a hundred years ago, the company has exposure in New Zealand, the UK, Americas, Asia and Ukraine. Aside from geographical diversity, GrainCorp's diversity of businesses provides a buffer against the volatility of seasonal conditions.

First half agribusiness was boosted by non-wheat commodities (chickpeas and canola seed), with exports tracking towards management's FY25 guidance range. The performance of GrainCorp's Nutrition & Energy (N&E) segment turned out particularly strong, Macquarie notes (energy in this case being recycled oil for biofuels), while the Feeds business was a key contributor.

The stock feeds business is counter-cyclical, Macquarie points out, with demand increased in dry conditions when crop production is lower.

XF Australia, a US-based specialist feedlot nutrition consultancy service provider acquired by GrainCorp in 2023, contributed above its business case.

Guidance

While GrainCorp's first half earnings beat consensus by 16%, this has only translated into a modest 3% upgrade to the mid-point of FY25 guidance. Morgans reminds investors GrainCorp does not have the leverage it once had to a big crop.

GrainCorp was once known as a classic weather stock but management has taken steps over the past 5-10 years to reduce its heavy reliance on Australias east coast grain harvest volumes. Historically, GrainCorps earnings would soar in bumper crop years and plummet during droughts, reflecting high operating leverage to grain volume.

Strategic changes, from portfolio restructuring to diversification and risk management, have make earnings more stable and less dependent on annual crop size.

UBS believes this week's 'beat' appears to have been aided by some mark-to-market timing benefit related to the canola crush, offsetting continued weakness in crush margins, export margin opportunities in chickpeas and canola seed, and outperformance in animal nutrition.

The more modest guidance upgrade looks to UBS to reflect a step-down in the N&E segment in the second half, driven by continued pressure on crush margins (in a seasonally lower second half), and unwinding of first half hedging benefits.

Within FY25 guidance, grain receivals were cut by -0.5mt, reflecting a softer summer crop and lower direct-to-port volumes in Victoria. The summer crop was impacted by flooding in Queensland and northern NSW, with southern NSW and Victora suffering from dry conditions.

Guidance excludes the business transformation costs of migrating to a cloud-based enterprise resource planning (ERP) system. The total estimated cost of the ERP migration program was increased by -$10m to circa -$160-180m, with most of this spend taking place over the second half FY25 and FY26.

While the transition to a cloud-based ERP system makes sense to UBS, at the risk of stating the obvious, near-term there is an ongoing risk of cost overruns and implementation delays naturally associated with a migration of this magnitude.

Underlying earnings guidance is now $285-325m compared to $270-320m previously, and $267.8m in FY24. The wide guidance range reflects (let's state the obvious again) "uncertainty in global trade policies".

New season opportunities in the fourth quarter are always the key swing factor, Morgans notes. Grain marketing margins will remain weak due to ongoing elevated global crops. Given ample supply and more expensive grain, Australia faces strong competition.

Agriproducts earnings will likely be impacted by a smaller crop which means GrainCorp will export less grain (high margin) compared to FY25. Morgans also expects N&E earnings will fall due to lower canola plantings and less carry-over grain in Victoria which will likely place further pressure on crush margins.

FY26

No more indicative of the ups and downs of agribusiness is the fact the flooding in that will impact on FY25 transforms into a boost to FY26. GrainCorp noted the "excellent rainfall" (one way of putting it) and soil moisture profile in Queensland and northern NSW sets the potential for a large harvest.

However, the south remains dry. Therefore, autumn and winter rainfall will be very important for dry-sown crops in Victoria and southern NSW. ABARES will publish its first forecast for this winter crop on June 3.

On that basis, UBS currently assumes an average FY26 east coast winter crop of 20mt, but sees potential for the crop to be well above average.

FY26 will also benefit from more operating leverage because GrainCorp will not need to make any crop insurance payment aside from its annual -$6m premium, meaning a potential $70m cost saving if the crop is 24mt or more, compared to the $10m saving currently assumed by UBS.

ABARES' first estimate of the FY26 winter crop is likely to be conservative, but that said, UBS suggests the key factor that will determine the extent of earnings upside is the margin backdrop, which seems to remain impacted by elevated global grain supply.