By Chris Shaw

The Australian Bureau of Agricultural Resources (ABARE) has revised up its forecasts for total winter crop production for the east coast regions of Australia to around 22 million tonnes.

This is an increase of 40% from the group's forecast in June and implies total production will be around 45% above the average for the past 10 years. The total Australian winter crop is now forecast to be 40.7 million tonnes, which would be the third largest Australian winter crop on record.

There remains some scope for the crop to fall short of ABARE's new expectations, as JP Morgan points out a larger crop means increased risk of damage arising from plague locusts in the south eastern states. The wet conditions also mean increased risk of stripe rust, which could impact on yields in some areas.

The upward crop revision has positive implications for Graincorp ((GNC)), as the company captures about 70% share of the production of wheat and barley in New South Wales and Queensland and about 50% share of production in Victoria through its bulk handling system.

Given a higher crop implies higher receivables, earnings estimates for Graincorp have been revised up on the back of the increases to the ABARE crop forecasts. As an example, JP Morgan has lifted its earnings per share (EPS) forecasts for the company by 1.5% this year, by 26.9% in FY11 and by 15.3% in FY12 to 52.7c, 90.5c and 78.7c respectively.

Credit Suisse had been expecting the revision so it notes the new ABARE estimates are broadly in line with its forecasts. Only the broker's FY11 numbers have been lifted, by 6%, so its EPS estimates now stand at 45.7c in FY10, 80.3c in FY11 and 73c in FY12.

Citi is forecasting EPS of 45.7c, 78.1c and 70.1c respectively, which means increases of 26% to its FY11 numbers and 6% to its FY12 forecasts. Consensus estimates according to the FNArena database now stand at 47.2c for FY10 and 77.4c for FY11.

As well as the increases to earnings estimates, the improved crop outlook offers greater certainty to earnings, reports Credit Suisse. This is a positive for the share price as investors are more likely to pay up for earnings certainty.

The other positive for Graincorp, in Citi's view, is its leverage to a larger crop, as this implies improved capacity utilisation and volume throughput and increased operational efficiencies. Add in the fact malt prices have risen by 30% in US dollar terms since June and Citi suggests earnings conditions at present are about ideal for Graincorp.

Citi sees scope for further earnings upgrades in coming months and suggests the improved earnings outlook is not yet fully reflected in the Graincorp share price, as on the broker's numbers the stock is trading on an earnings multiple of less than 10 times in FY11.

This implies solid potential share price upside, as evidenced by Citi's revised earnings estimates generating an increase in its price target for Graincorp to $8.80 from $8.00 previously. JP Morgan has similarly lifted its price target to $7.60 from $7.10 to reflect the increases to its own earnings estimates.

Post the ABARE crop revision there have been no changes to ratings for Graincorp, the FNArena database showing the stock is rated as Buy four times, with an average price target of $7.93. This is up from $7.67 prior to the update.

Shares in Graincorp today are stronger and as at 1.35pm the stock was up 25c at $7.70. This compares to a range over the past year of $5.10 to $9.08 and implies upside of almost 7% to the average price target in the database.

By Greg Peel

On the television news last night there was a typically ill-informed tone around the report that BHP Billiton ((BHP)) had just made a takeover offer for Potash Corp of Saskatchewan. Why, asked the reporter, would the world's biggest diversified mining and energy company suddenly want to get into agriculture?

Those paying attention to the stock market would know that BHP has had fertiliser in its sights for some time. A potential offer for Potash Corp had long been muted, but its likelihood was complicated by BHP bidding for rival Rio Tinto ((RIO)) instead. Marius Kloppers still sends Graeme Samuel Christmas cards for not having managed to reach any sort of ACCC decision on such a merger before the GFC hit and exposed Rio's perilous debt position.

But a takeover also diminished in likelihood when BHP simply moved in next door to Potash Corp.

Crops require three main sources of nutrients – phosphate, nitrogen and potassium – in order to grow healthily. Across the globe, farmers deliver these nutrients through fertilisers, and the potassium element is provided most commonly by potassium chloride, although other potassium compounds can be used – all known throughout history collectively as “potash”. Potash reserves are found in land basins where ancient oceans have long ago evaporated, and the three largest basin sources are found in Russia, Belarus and Canada. Canada boasts the largest reserves (52% compared to Russia's 21% and Belarus' 9%), found in the sweeping central prairie state of Saskatchewan. This has allowed the Potash Corp of Saskatchewan to become the world's biggest fertiliser company.

There are two reasons mining and oil company BHP would be interested in fertiliser. Firstly, while BHP's businesses are diversified across minerals and metals and oil, all its products largely follow the same cycles. But food is a staple – more staple even than oil – and hence it is not necessarily beholden to those cycles. By expanding into fertiliser BHP can thus diversify its cyclical exposure, and obviously the rise of emerging middle classes in the likes of China and India offer unfathomable upside for food demand. It's not just a matter of population growth, it's a matter of that population moving up the economic scale from subsistence farming to supermarket shopping.

Secondly, potash is mined from deep underground. And BHP has a bit of experience in mining.

Prior to 2006 the potash price was relatively stable, but when global demand began to outstrip new supply the price began to take off. While food is a staple, potassium fertiliser isn't necessarily, and as such it still suffers from simple price elasticity. Goldman Sachs notes global potash demand peaked in 2008 but then plunged 28.5% in 2009. When the GFC hit, farmers simply couldn't afford it so they just had to live without it. But we're not expecting a GFC every few years.

While pundits have long thought a cash-laden BHP might make a move on Potash Corp, instead it first entered into a joint venture with (2006), and then acquired all the shares of (2008), Anglo-Potash. Anglo-Potash's operations are also based in Saskatchewan, and it was only in June that BHP announced a potash reserve at its Jansen project in Saskatchewan of 3.37bn tonnes at 25% potassium oxide.

So realistically, BHP now has the capacity to be another Potash Corp on its own, albeit first sales are not expected until 2015.

With such a reserve under BHP's belt, analysts began to assume a takeover offer for Potash Corp was no longer on the cards. This was further reinforced when BHP espoused a post-GFC strategy of “building, not buying”. Analysts rate BHP highly not just for its existing iron ore business but for its many and varied greenfield and brownfield projects across the globe. And Rio's disastrous takeover of Alcan provided a stark reminder to BHP that organic growth is much safer than acquisitive growth.

There but for the grace of God.

So to suddenly take a swing at Potash Corp, BHP is bald-faced in contradicting its own stated strategy preference. What could be the benefits?

Well firstly, Potash Corp has long been up and running and Jansen is a 2015 proposition. Obviously there are synergies to be had in also acquiring all the potash reserves that are all but next door, and clearly along with the reserves comes decades of potash market expertise and nous. Potash Corp also has a 54% stake in one one of the world's largest distributors of potash – Canpotex – which would thus give it an immediate channel to market.

Secondly, at US$130 share (the current offer price) analysts calculate the deal to be about 3% earnings accretive, so it's not necessarily like BHP is throwing good money after bad. UBS speculates BHP is anticipating the proposed iron ore JV deal with Rio will be disallowed, and hence it will not have to fork out the US$5.8bn equalisation fee. This will help with the US$39bn BHP is offering to Potash shareholders.

The problem is BHP will simply have to pay more than US$130 per share. As this represents only a 16% premium, and most takeovers are won on at least a 30% control premium, there's no surprise the Potash Corp board took only a heartbeat to reject the offer.

One assumes, however, that BHP has simply been caught out by the weather.

Obviously, Kloppers did not just wake up on Monday morning and declare “Let's go and buy Potash Corp”. There would have been weeks or months worth of work behind the scenes to arrive at a US$130 bid. Only last month Potash shares were trading at US$85 which would make US$130 a 53% premium, but drought and fires in Russia and floods in China and Pakistan have sent global grain prices soaring in the meantime. Where goes the price of food goes the price of fertiliser. BHP's offer probably looks a bit wimpy simply on a matter of unfortunate timing.

So what will BHP have to pay? Well, Deutsche Bank suggests it could pay US$155 before the deal is not value accretive (3% accretive at US$130), which would be a more realistic 38% premium measured from the same starting point, while Citi adds in a synergy assumption to suggest the deal is still earnings accretive at US$170. Yet talk in the market is that the Potash Corp board would snub anything under US$180.

The other problem is that even at US$130, assuming an all-cash bid, BHP's gearing level would rise above the company's limit of 50%. This would likely mean asset sales elsewhere, but it also would rule out any capital management. BHP shareholders are not likely to get Potash and a share buyback.

Credit Suisse notes that if BHP spent the same amount on a buyback it would immediately be 10% earnings accretive.

So what do analysts think of the idea of BHP increasing its offer? Perhaps Citi sums up the feeling with its headline this morning: “Walk Away Before You Overpay”.

But BHP has already gone “hostile”. This means it does not try to negotiate a price the Potash board is happy with but goes straight to Potash shareholders instead. Indications are, however, that major shareholders are also going to hold out for more.

It is for this reason BHP shares have been given a caning yesterday and today. Rio shares have risen in contrast, because suddenly Rio looks like the safer bet for iron ore exposure if BHP is going to start throwing money around willy-nilly.

And then there's Incitec Pivot ((IPL)), Australia's largest fertiliser producer. The global agricultural sector has already been set on fire by M&A activity (see AWB Bid Fires Up The Agri Sector), and BHP's bid for Potash has sparked a re-rating of all fertiliser producers.

Credit Suisse believes earnings upgrades for Incitec are “inevitable” anyway given rising soft commodity prices and falling soft commodity inventories, and that BHP's bid highlights the fact Incitec is currently inexpensive.

Deutsche agrees the bid is positive for the sector as a whole, but does not believe a bid for Potash Corp automatically makes Incitec an obvious target as well, and certainly not from BHP. Incitec produces diammonium phosphate (DAP) and not potash, and 50% of the company's earnings come from explosives, not farming. In 2006, when BHP entered the potash JV with Anglo-Potash, it also sold its Southern Cross fertilisers phosphate business to Incitec.

If BHP does buy Potash Corp it will also pick up the company's smaller phosphate and nitrate businesses, and perhaps will divest them. The target for BHP is clearly the fertiliser product it can mine.

But what are the prospects for the potash price, as opposed to the Potash Corp price?

Citi notes that 2008's peak demand for potash globally was 50mt, which fell to 30mt in 2009 and is forecast to be 45mt in 2010. Global capacity currently stands at around 60mt, so Citi can only see BHP's move as a “long term call” on the potash market. Aside from BHP's own potash reserves at Jansen and Potash Corp's own expansion plans, America's fertiliser giant Mosaic and BHP rival Vale of Brazil are also moving to expand supply.

There is a risk BHP is trying to buy into what will become a crowded and potentially oversupplied market, at least in the nearer term.

By Greg Peel

After long hard years of drought, commodity price ups and downs and court room drama, Australia's once mighty agricultural sector has has had a tough time of it in recent years. Underlying the volatility has been a widely held view that food is becoming a more valuable resource given exponential population growth and the emergence of new economies, and as such listed agri companies are a good long term bet. But it's been a rough ride.

That view has not necessarily diminished, but it has once again been brought into focus by soaring grain prices – the result of Russian drought and fires and floods in China and Pakistan. Were high prices the reason why Canada's Agrium has suddenly moved on Australia's AWB? Unlikely.

It has been an inevitable result of the GFC that industry consolidation has since been ongoing, as money moves “from weak hands to strong”. Such recessions bury the weak but the strong can survive to become stronger by picking over the corpses, or by targeting the weak in the herd. No more has this been apparent than in the global, and particularly Australia's, mining sector, with China leading the charge to push metal and mineral prices higher. But it is oft forgotten Australia is also a major exporter of agricultural produce.

Yesterday Calgary-based Agrium – a wholesaler/retailer in the North American agri market – made an all cash offer at $1.50 for AWB ((AWB)). Formerly the Australian Wheat Board, AWB, offers rural services and commodity management in Australia and elsewhere.

The bid eclipses an earlier merger offer from Graincorp ((GNC)), which provides handling and marketing services to Australian grain growers. Stock analysts saw such a merged entity as being a sensible one, but the Agrium bid has now trumped the GNC offer. It is, however, conditional, both on due diligence to be performed by Agrium and FIRB approval. Until both hurdles are cleared, AWB still has an attractive offer from Graincorp standing.

Will Graincorp up its offer? Analysts see some scope for an increase before the deal becomes earnings dilutive (Citi suggests $1.55 is possible) but the fact is while an attractive proposition, an AWB merger is not a desperately needed move for GNC. There is no need for GNC to enter a bidding war.

Will another counter-offer emerge? This is quite possible. Last year Agrium's Canadian competitor Viterra took out ABB Grain – the old Australia Barley Board – which suggests current moves in the sector are not just about a sudden jump in grain prices. It's a wider strategy, albeit strong grain prices only serve to focus attention.

Will Viterra counter perhaps? Or someone else? Anything is possible at this stage. But what the latest move does suggest is that the Australian agri sector is in play, and AWB may not be the only possible target. Agrium's bid for AWB represents a 40% premium, notes Citi and a significant premium to the company's net tangible asset valuation.

Citi thus believes Graincorp itself could be a target, along with struggling players such as rural, financial and real estate services player Elders ((ELD)) and livestock nutri-product producer Ridley Corp ((RIC)).

But the story gets even more complex.

Elders in particular has been considered to be a possible takeover target already from domestic suitors. National Bank ((NAB)) has had its eye on Elders' rural bank, while Wesfarmers ((WES)), which boasts agribusiness in its portfolio as well as coal and Coles, and fertiliser producer Incitec Pivot ((IPL)), have been suggested as possible buyers of the balance.

There has even been talk that Wesfarmers might be eying Incitec or Incitec eying Wesfarmers' agribusiness.

Incitec, for one, might have reason to see the need for some consolidation. Agrium's attempted move into the Australian market is to secure new distribution channels for its agri products, which include fertilisers and crop protection products. Thus Agrium will emerge as a competitor for Incitec's local phosphate market, along with Nufarm's ((NUF)) glyphosate market. BA-Merrill Lynch does not see the competition as having an FY11 impact, but it would look to trim FY12 earnings forecasts were the AWB takeover to proceed.

It's all enough to make a farmer's head spin. Traders, however, are licking their lips in anticipation.