GrainCorp ((GNC)) suitor, Long-Term Asset Partners (LTAP), has walked away after completing due diligence and withdrawn its acquisition proposal. GrainCorp will now move forward with its plans to divest the bulk liquid terminals business and pursue a de-merger of its malt division from the combined grains & oils division.
Morgans considers it fortunate the company has progressed its portfolio review in parallel with the LTAP due diligence process, now that the takeover bid has fallen over. Deutsche Bank agrees the game has changed, as the takeover approach has prompted a complete re-analysis of the business model and led to, among other things, the grains derivative, which has potential to significantly smooth earnings.
While the withdrawal of LTAP may be a negative development, the broker believes the de-merger proposal by GrainCorp offers compelling value. Based on Deutsche Bank’s base case, the malt business is valued at $7.06 a share, while the market is currently valuing the grains & oils business at $1.09 a share.
There is some lingering doubt for Bell Potter as to what LTAP found six months into due diligence process, and investors are advised to weigh up whether the share price has fallen sufficiently to make the business attractive as a play on east coast grain.
UBS acknowledges there was always a risk that a potential suitor discovered something materially negative in the business which is not easily visible from the outside, but takes the view that the de-merger will unlock value.
The broker finds the sum of its valuation is $10.35 a share, versus the $10.42 a share takeover offer from LTAP. The broker’s calculation applies a 9x enterprise value/FY21 earnings ratio for the malt business and 7x for the new GrainCorp business.
UBS assesses the share price performance of an Australian parent and the spin-off company has generally been positive over the years. GrainCorp has also highlighted the receipt of other approaches for all, or part of, the business since the LTAP proposal was announced.
Hazy Outlook
The main determinant of the outlook will be how the market assesses the value of the assets, ex-malt, with the potential for reduced earnings volatility. Neither the extent of this nor the cost to achieve it has been articulated. Bell Potter believes, to buy GrainCorp at the current share price, would require conviction that residual assets can more than double earnings, or that a materially higher multiple can ascribed to these assets compared with previous assessments.
The broker envisages more value in other drought affected businesses such as Elders ((ELD)), Nufarm ((NUF)), Bega Cheese ((BGA)) and Select Harvests ((SHV)), which have more transparent earnings models. GrainCorp, on the other hand, is more leveraged to effectively price grain into a higher fixed-cost infrastructure network and, therefore, more exposed to trading returns and an exportable surplus.
Bell Potter, not one of the eight stockbrokers monitored on the FNArena database, has a Hold rating and $8.50 target. Morgans downgrades to Reduce from Hold, given there is at least two tough years ahead of the company.
The focus is now on a poor FY19, as well as the current season, which is also turning out poorly. There will be the smallest east coast grain crop in over a decade, while grain marketing has been affected by China’s anti-dumping investigation into Australian barley exports. Meanwhile, weak oilseed crush margins have affected the oils business.
Morgans expects a loss from grains and material weaker earnings from oils when the company reports its first half result on May 9. This will not help the investment case for the residual business that combines these two under the de-merger proposal. The broker also forecasts a loss in FY19 for GrainCorp and considers the next opportunity to benefit from an average season on the east coast will not be until FY21/22.
Derivative Uncertainty
In the absence of a derivative instrument, the new GrainCorp is likely to trade at a material discount to an average season valuation because of difficult trading conditions, the broker adds. While the proposed derivative instrument should protect shareholders in poor seasonal conditions, Morgans points out it will also cap the upside in good seasons. However, the market may, in time, apply a higher multiple to this business if it becomes more comfortable about the intended benefits.
FNArena’s database shows three Buy ratings and one Sell (Morgans). The consensus target is $9.56, signalling 17.3% upside to the last share price. This compares with $9.93 ahead of the announcement. Targets range from $7.90 (Morgans) to $10.96 (Deutsche Bank).
