I was having a look through Graincorp Ltd's (ASX: GNC) previous five years of annual reports this morning, wondering why the company was so expensive in price-to-earnings (P/E) terms. Despite being a fairly capital-intensive agribusiness, sensitive to both commodity markets and the weather, Graincorp has traded between $8 and $10 for much of the past five years.
Failed takeover offers from Archer Daniel Midlands (ADM) – at $13.20 per share – notwithstanding, I struggle to see why the business would be an opportunity today. Underlying profits are down 75% from $205 million in 2012 to $53 million in 2016 – and the company has recorded significant 'one-off' expenses in 4 of the past 5 years.
A 2013 plan to increase Underlying Earnings Before Interest, Tax, Depreciation and Amortisation (UNEBITDA) by $110 million by 2016 failed. That should have put 2016 UNEBITDA at $505 million – but it came in at just $256 million, instead.
Admittedly there have been a few upsets along the way. A change of CEOs and long-lasting droughts, not to mention an increase in competition and a change in the structure of the business, which now focuses more heavily on processing. A number of capital investments in expanding the malt and oil businesses in recent years should help mitigate some of the company's earnings variability.
A turnaround story?
Recent history aside, it's possible that Graincorp is now at the bottom of the industry cycle. Higher demand for malt for craft beer processing reflects an interesting growth avenue, and low oil prices have resulted in unusually low freight costs, which have increased competition in global markets. A normalisation in freight rates, which could occur as excess capacity leaves the market, would improve Graincorp's competitiveness. The company is also tipping a stronger growing season from Australian farmers this year, which would be another potential driver for higher earnings.
Graincorp also has a good financial position, with $7.32 in net assets per share, including $500 million in intangible assets. Approximately 40% of this is property, plant, and equipment, with another big chunk in inventory and around $1.30 per share in cash. Gearing (net debt divided by net debt + equity) is modest at 17.5%.
Yet for a business like Graincorp, I'd prefer to get it closer to something like 12x earnings, instead of the 40x last year's profits that shares currently sell for. The high levels of net assets – in fairly strategic locations and attractive to foreign buyers – pretty much prevents that from happening, which puts me at an impasse. I'm leaving Graincorp on the shelf.
