Pros & Cons From GrainCorp’s Transformation

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FY25 looks like providing a bumper harvest, but weaker grain trading and crush margins due to strength in global crops will keep GrainCorp earnings under pressure.

-FY24 proves a more average year for GrainCorp
-FY25 crop set to be bumper
-Pressure on margins undermines earnings upside
-Strong balance sheet allows for ongoing capital management

By Greg Peel

The rollercoaster that is GrainCorp’s ((GNC)) global weather-related earnings continued in FY24. Following three very weak years of Australian drought, two years of La Nina brought record returns in FY22-23. FY24, on the other hand, was a year of mean reversion to a more average performance.

The numbers thus look shocking, but aren’t. Revenue fell -21% year on year, earnings fell -53% and profit fell -69%. Cash flow was down -77%. The result was in line with guidance, and largely in line with analyst expectations who commented the result is “solid”.

Earnings fell on a combination of a smaller East Coast of Australia (ECA) crop meeting lower grain marketing margins and more normalised oilseed crush margins due to global influences. There was also a significantly smaller fair value gain in GrainCorp’s remaining shareholding in United Malt Group.

Despite the big fall in cash flow, GrainCorp was able to reward shareholders with an attractive dividend thanks to a carried-over core cash holding. Make hay while the sun shines, and put it in a silo.

FY25 Outlook

GrainCorp does not typically provide quantitative guidance at its full year (September year-end) result, preferring to wait until the AGM in February when the harvest is completed. Who knows what the weather might do? But qualitatively, GrainCorp has highlighted an earlier start to the FY25 season and indications this year’s crop is heading to be up there with the best.

However, the company’s earnings leverage to crop size will be weaker than in recent years due to below-average grain trading margins and weak canola crush margins. There have been solid crops elsewhere in the world.

In FY25, GrainCorp will benefit from a well above-average crop following favourable seasonal conditions in Queensland and NSW, though Victoria has been dry. ABARES forecasts ECA winter grain production to be up 22%. This would be the fourth largest crop on record and is some 50% above an “average” year, with early-season grain receivals well ahead of last year. The next update on this crop from ABARES is due on 3 December.

Yet grain marketing margins are expected to fall further in FY25 given bigger global crops and lower USD grain prices versus AUD prices, Morgans notes. This means the spread is materially less than during the bumper FY22-23 period and GrainCorp’s marketing margins; profit will be tight. While crush volumes will remain high, crush margins are anticipated to also fall further in FY25.

Despite record crush volumes in FY24, Nutrition & Energy segment earnings were down -33% year on year with management noting ongoing pressure on crush margins which are being exacerbated by a poor FY24-25 Victorian canola crop.

Grain production across ECA is shaping up to be near record and this is a positive for trading and export volumes. Management remains cautious on margins due to limited grower selling and amid ample global supply. As the Australian harvest progresses, selling pressure should begin to emerge which benefits export margins, Macquarie notes. A lift in the global wheat price is a key signal for further recovery in margins.

In Nutrition & Energy, volumes across Feeds & AgriEnergy look set to remain strong, but lower crush margins are a headwind.

Transformation

GrainCorp has announced a new Business Transformation Program. This program is designed to modernise the company’s systems so that it can continue to improve efficiency and reduce complexity across the business. The company will effectively be transferring to an upgraded SAP software system.

GrainCorp is targeting a $20-30m earnings uplift in through-the-cycle earnings from this program in addition to its current $320m target. Some of these benefits will be seen in FY26, with the full benefits to come in FY27, Morgans notes. At the mid-point, GrainCorp is likely to spend around -$150m on this program.

Morgans assumes the majority of the spend will occur during FY25. At the mid-point of the benefits, or $25m, this would imply a return on investment of 16.7%. There will also be working capital benefits.

Renewable, One Day

Despite a weak FY24, GrainCorp’s balance sheet remains solid, Macquarie notes, with $337m in core net cash underpinning growth options such as organic growth or bolt-on acquisitions, the $50m buyback which is some 59% complete, and an ongoing healthy level of dividends.

But given the material fall in crush margins, GrainCorp’s potential investment in a new oilseed crush plant with a capital cost in excess of -$500m isn’t looking so appealing, Morgans suggests. The company is in discussions with Ampol ((ALD)) and super fund IFM regarding a biofuel opportunity, but the large capital commitment remains some years away, with GrainCorp signalling the front-end engineering & design (FEED) stage would not be until FY26.

The decision needs government support and mandates, Morgans notes, and even if it gets the go ahead, it will take a couple of years to construct and commission. The broker recognises renewable fuel demand is forecast to grow strongly over the coming decade to meet decarbonisation commitments.

Target Price Cuts

GrainCorp’s FY24 result may have been in line with expectations but FY25 is facing a balance of volume tailwinds and margin headwinds, leading brokers to cut their earnings forecasts and lower their price targets.

Morgans has cut its target to $8.81 from $9.45 and, as this represents less than 10% upside to the trading price, retains a Hold rating.

Bell Potter’s Hold rating is also unchanged. Looking into FY25, this broker sees the prospect of a stronger crop balanced by headwinds in canola crush margins and variable grain trading opportunities. On face value, the upside leverage to the FY25 crop looks broadly captured in consensus expectations, Bell Potter suggests.

Bell Potter’s target falls to $9.25 from $9.80.

Leverage to higher grains production across ECA drives Macquarie’s expectations of 22% earnings growth in FY25. Longer term optionality via a strong balance sheet with potential growth options (M&A, crush expansion) and further capital management keeps Macquarie on Outperform with a $9.85 target, down from $10.07.

Taking a different spin, Ord Minnett’s investment thesis that GrainCorp’s through-the-cycle earnings and port assets are undervalued remains unchanged. This valuation gap, coupled with the capacity for further capital management initiatives, has this broker retaining a Buy recommendation with a target price of $9.80, down from $10.05.

UBS also retains Buy, cutting its target to $9.60 from $9.80.

That leaves three Buy or equivalent and two Hold ratings among the five brokers monitored daily by FNArena covering GrainCorp. The consensus target is $9.46, down from $9.83 previously.

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