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Wheat warning: GrainCorp's time in the sun unlikely to last

Lewis Jackson  |  17 Mar 2022Text size  Decrease  Increase  |  
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Graincorp is on a tear. Shares are up 100% since early 2021, sketching a trajectory more like a hot electric vehicle start-up than a formerly state-owned grain handling and logistics business.

Markets are responding to a string of positive and unprecedented surprises for the company: two years of record Australian wheat harvests, poor growing seasons in the Northern hemisphere and a vertiginous jump in wheat prices following Russia’s invasion of Ukraine.

But investors eyeing a speculative bet on Graincorp (ASX: GNC) are at risk of buying the peak, says Angus Hewitt, Morningstar equity analyst. High prices only marginally impact GrainCorp’s volume-based handling business over the longer term. The company is benefiting from the two largest wheat harvests on record but is unlikely to enjoy a third. As bumper harvests fade, so will GrainCorp’s bumper profits, he says.

“It’s not the time to jump in,” Hewitt says. “This is peak earnings for GrainCorp. I don’t see them making these sorts of earnings for a long time, if ever. Everything has come together perfectly for them.

“Longer-term value is dictated by an average growing year. Droughts happen, bumper years happen. But they’re minor fluctuations in the scheme of things. This year they’re going to enjoy big profits and these sorts of years I don’t expect to happen very often at all.”

GrainCorp’s long rally has narrowed the upside for even the most bullish analysts. Shares closed on Wednesday at $8.45, just off the highest price ever and a 41% premium to Morningstar’s fair value of $6.00. The average price target across eight industry analysts is $8.08, with the most bullish target around $9.30, according to Pitchbook data.

“There’s just grain everywhere”

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GrainCorp’s meteoric share price rise began in early 2021 as the company benefited from bumper Australian harvests. This coincided with a jump in global wheat prices, says Hewitt.

Australian growers harvested 33 million tonnes of wheat in the 2020-2021 growing season, more than double the year before. The Department of Agriculture forecasts the fiscal 2022 harvest will top out above 35 million tonnes, the biggest on record, thanks to exceptional weather conditions and high levels of cultivation. Wheat made up just over half of Australia’s total production of crops by weight last year.

The profitability of GrainCorp’s handling and logistic business—about three quarters of EBITDA in fiscal 2021—is mostly determined by how much grain it stores and moves, says Hewitt. Two mega harvests boosted revenue as more wheat flowed through its network of country siloes, rail carriages and port storage facilities. Graincorp more than doubled the amount of grain it handled in fiscal 2021 compared to fiscal 2020.

“There’s just grain everywhere. On farms, in storage, all through the supply chain,” he says.

Bumper Australian harvests coincided with a jump in global wheat prices due to poor growing conditions in the Northern Hemisphere. As local growers rush to export crops and take advantage of record prices, Graincorp has been able to boost margins by charging customers more to access increasingly scarce storage and transport capacity, says Hewitt.

“Graincorp couldn’t normally say, ’You’re earning a lot from your grain so we’re going to take a big cut’,” he says. “People wouldn’t accept that because there are other options. But, at the moment, there isn’t much capacity in the network so they’re able to raise prices. But we’re not going to have bumper crops forever.”

The combination of higher volumes and bigger margins saw EBITDA hit $331 million in fiscal 2021. Hewitt forecasts it will jump to $502 million this year, compared to the six-year average of $95 million.

Conflict in Russia and Ukraine will have a moderate impact

Russia’s war in Ukraine has sent global wheat prices soaring to new highs but higher prices have a limited impact on GrainCorp, says Hewitt.

Wheat markets have swung wildly as traders bet on the likelihood war in Ukraine could disrupt this year’s Black Sea harvest, due to start in June or July. Russia and Ukraine are collectively responsible for roughly a third of global wheat production.

Wheat futures on the Chicago Mercantile Exchange leaped 63% to a high of $1.425 per bushel in the days after the 24 February invasion. Prices have since eased to $1.069 a bushel, 22% above pre-invasion levels.

However, higher prices are only marginally beneficial to GrainCorp’s volume-based business model, says Hewitt.

What matters most is the size of wheat harvests, which are forecast to fall as fertiliser costs rise and farmers swap wheat for other crops or livestock. The Department of Agriculture expects the annual wheat harvest to drop 23% next year and another 19% in fiscal 2024. Smaller harvests will shrink how much wheat passes through GrainCorp’s facilities. By freeing up capacity at siloes and ports, it will also make it harder for GrainCorp to charge premium fees, shrinking its margins.

GrainCorp’s food oil segment, which includes Australia’s second-largest oilseed crushing business, is often less volatile and could help cushion some of the blow from falling harvests, says Hewitt.

However, ultimately, the company remains at the whims of the weather, transporting and storing a commodity for which it has little pricing power or cost advantage, he says.

“GrainCorp has mostly generated negative historical returns on invested capital.

“Earnings from the storage and logistics, as well as marketing businesses have historically been volatile.”

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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