One of the worst droughts in a century is not only NSW ravaging farmers, it is also eroding the profits of several ASX-listed companies.

Despite much needed rainfall overnight, parched towns across western NSW continue to suffer, and analysts say the rural sector at large – from growers to marketers – is suffering.

"The below average 2018-19 winter crop will not only impact broadacre growers, processes and marketers (GrainCorp and Naomi Cotton) but will cause domestic feed costs to remain at record highs … and challenge the profitability of protein producers (Ingham) and feedlot operators (Australian Agricultural Company and Elders)," said Morgans analyst Belinda Moore.

"The poor seasonal conditions will also weigh on rural services businesses (Elders, Ruralco Holdings, Nufarm and Incitec Pivot) with farmers less inclined to purchase farm inputs, such as fertiliser and agchem, and agency earnings are expected to be impacted from the sharp decline in cattle prices as cattle herds have been liquidated," Moore said.

Image of drought-stricken landscape

Agricultural chemical company Nufarm (ASX: NUF) says the drought is partially to blame for earnings losses. It recently reported a net loss after tax of $16 million for the 2017-18 fiscal year, down from a profit of $114 million the previous year.

Earnings before interest, taxes and amortisation fell to $386 million down from $390 million.

"Australia experienced one of the driest autumns since records began more than 100 years ago, leading to an extremely poor winter crop season. The Australian crop protection market is down substantially as a result," the company said in after delivering its full-year results for the period ending 31 July 2018.

"A partial earnings recovery is forecast in Australia for [2018-19], with drought-related impacts most pronounced in the first half."

However, Morgans' Moore said: "Its outlook commentary (both FY19 and FY20) assumes average seasonal conditions and a good post-emergent market which is far too early to know at this stage."

Reflecting that uncertainty, Nufarm's shares recently dropped to a 3½-year low of $5.97. At 11am Sydney time they were trading at $5.99.

While storage specialist GrainCorp (ASX: GNC) says its diversified business model has helped to insulate it from the drought, its grains business has suffered. In a September trading update, the company said "cropping conditions across the east Australian grain belt have deteriorated substantially, with large areas of NSW and Queensland in severe drought."

GrainCorp chief executive officer and managing director Mark Palmquist said he expected “a considerable decline in grain production in eastern Australia in FY19 with production again skewed to Victoria and southern NSW."

But Morningstar analyst Adam Fleck is maintaining a $8.30 per share fair value estimate for GrainCorp, suggesting its shares are fairly to slightly undervalued. GrainCorp’s shares were down from a high of $8.99 in April to their current price of $8.36.

"In this business, lower volumes of grains (particularly wheat) through the company’s storage silos and other logistics assets negatively impacts revenue, and because of a high degree of fixed costs, hits profits even more so. Following a bumper crop in the year prior, this year is shaping up to be very challenging for this segment — likely one of the worst in nearly a decade," says Fleck.

"That said, there are still positives for GrainCorp longer term … we don't believe GrainCorp's competitive position has taken a permanent hit. Alongside a normalised weather environment, we also expect fixed-asset reduction and better-structured rail haulage contracts to drive improved profitability for the segment going forward.

"Second, we’re encouraged by positive performance in GrainCorp's North-American-focused malt business, where the firm enjoys secular growth, stemming from rising craft beer volumes, and solid profitability," said Fleck.

The drought has also accelerated SunRice’s plans to list on the ASX. The company's shareholders recently voted on a proposal to transfer B Class shares from the National Stock Exchange to the ASX. The listing will retain SunRice’s dual class share structure and A Class Grower Shareholder control.

"Importantly, being listed on the ASX will provide SunRice with access to a deeper pool of capital, improving the ability to raise funds to accelerate the 2022 Strategy," the company said.

"SunRice is subject to cyclical and unpredictable changes in business conditions, such as the drought presently being experienced in the Riverina. Accelerating the 2022 Strategy will ensure the ongoing growth and resilience of the business, so that Riverina growers can maximise their returns when planting rice is viable again."

As for the supermarkets, Morningstar retail analyst Joahnnes Faul said he doesn't expect Coles’ and Woolworths’ bottom lines to be materially impacted by the drought as "inflation in produce is generally passed on to the consumer in higher pricing."

More from Morningstar

Commitment to growth boosts Xero's fair value

Equity Mates: 'We were foolishly overconfident investors'

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

Nicki Bourlioufas is contributor to Morningstar Australia

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.