openbriefing.com
GrainCorp Limited today reported net profit of $87.7 million for the first half ended March 2011, up 66 percent from the previous corresponding period (pcp). EBITDA was $172.9 million, up 55 percent, reflecting a record eastern Australian winter harvest and more grain tonnes marketed. You’ve increased your EBITDA guidance for the full year to September 2011 to $310 million to $340 million, up from $275 million to $310 million, implying second-half EBITDA of $137 million to $167 million versus $100 million in the second half of 2010. What assumptions underlie this guidance and what are the risks to achieving it?

MD & CEO Alison Watkins
The main assumptions are around grain volumes because earnings in our Australian grains businesses are very much volume driven. We’ve upgraded our expected grain country receivals to 15 million tonnes, up from our previous guidance of 14.5 million tonnes and well above the 10 to 13 million tonne range we started out the year with. We also now have a better idea of our likely carry-out position at the end of the year, where we expect more than 6 million tonnes of grain will remain in our system at the end of the year, generating storage revenues through the second half.

Exports handled are another key driver of earnings for us, and we’ve upgraded our export volume guidance slightly to 7 to 8 million tonnes from 6.5 to 7.5 million tonnes. On grain logistics, we’re more confident in our ability to access the necessary trucks and trains to get the grain to port. That was a challenge for us in the first half because of the impact of flooding in Queensland and Victoria.

In our grain marketing business, which sells grain to end users such as flour mills, maltsters, oilseed crushers and stock feed manufacturers in Australia and offshore, we’ve marketed more grain in line with the crop size and our strategy. The business has improved its profitability and we believe we can build on that.

The main risks to our earnings guidance are forex and grain price volatility. In our Malt business, the majority of our sales for the year are committed, but the exchange rates of the US, Australian and Canadian dollars, the British pound and to some extent the Euro, will have a translation effect on our earnings. We have strong risk management strategies in place to manage price volatility.

openbriefing.com
The first-half earnings improvement primarily reflected a significant increase in contributions from the ports and grain marketing businesses, which was slightly offset by reduced contributions from the malt and Allied Mills businesses. Given part of GrainCorp’s rationale for having processing and downstream production is that they mitigate the seasonal volatility of Group earnings, can you comment on your level of comfort with the Group’s existing portfolio and its first-half performance?

MD & CEO Alison Watkins
All of our businesses operate in cyclical industries: even the malt business, which is certainly less volatile than the grains businesses, has a cycle. Nonetheless, we expect the malt business will always contribute positive earnings, which combined with our grains businesses’ reliance on grain production volumes and the volatile nature of production experienced in eastern Australia, means the Group should avoid loss making years such as the 2007 and 2008 drought years.

Our grains businesses are having an unprecedented year. The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) estimates 2010/2011 eastern Australian grain production will be above 24 million tonnes, up 60 percent from the previous year. It’s a big year for volume based businesses like ours.

In malt production, we’re pleased with the results since acquisition in 2009. Due to lower beer demand in developed markets and the effect of the strong Australian dollar on the competitiveness of our malt exports from Australia and Canada, our reported malt margins have softened in line with expectation over the last 12 months. We remain very comfortable with the quality of the malt businesses we have and see opportunities to continue to strengthen our position in the event of industry consolidation and malt margin downturn.

Allied Mills is a smaller part of our overall portfolio, and it’s having a tough year, particularly because of the difficulty in the current environment of passing on high wheat prices to its customers. Also as you’re aware, Allied’s Toowoomba mill was severely impacted by the devastating flash floods earlier in the year and we’ve had to move a lot more product around the country, incurring extra logistics costs.

openbriefing.com
The first-half result included a $40.4 million mark-to-market gain on derivatives, versus a gain of $4.7 million in the pcp. To which parts of the business does this gain relate? To what extent do you expect such a contribution to the full year result?

CFO Alistair Bell
The gain relates to our grain marketing segment. It reflects the hedging positions we have in place around our commodity inventory, which rose to $528 million as at 31 March. Over the remainder of the financial year we expect this mark-to-market gain to convert to a realised gain as the inventory is sold and delivered.

It’s worthwhile noting that we focus on selling grain direct to the end-user such as the miller, maltster, crusher or stockfeed manufacturer, using hedged commodity inventory rather than speculative trading. In fact, in the first half over 75 percent of our executed sales volumes represented tonnes delivered to the end user, with the balance delivered to other traders, merchants and grain marketers. The mark-to-market gain reflects the derivative positions for sold but not yet delivered grain, and unsold grain.

openbriefing.com
Operating cash flow for the first half was $133.7 million, versus outflow of $56.8 million in the pcp. Cash flow included proceeds of $560.4 million from a secured commodity inventory funding facility, versus repayment of $53.3 million in the pcp. What is the rationale for this change in inventory funding structure? What is the typical time-frame of funds borrowed under the secured facility and how do its terms compare with those of your other borrowings?

CFO Alistair Bell
Our debt strategy is to match funding with asset life, and we outlined this at our Investor Day in early February. Our term debt, or longer-term funding, supports corporate planning and efficient capital management whilst our inventory financing is covered by our short-term facilities. The latter have limits and maturity reflecting the seasonal nature of the grain marketing business. The facilities are “operational” in that they specifically fund the grain marketing inventory, and the associated interest cost goes to cost of goods sold.

Last year, prior to introducing our current debt strategy, we were using our cash reserves rather than short-term facilities to fund the grain marketing inventory. It’s therefore difficult to make a meaningful prior-year comparison.

openbriefing.com
The malt business, which you acquired in November 2009, reported EBITDA of $57.3 million for the first half, down from $58.6 million in the four and a half months to March 2010, on revenue of $416.7 million, up 27 percent. EBITDA margin was 13.7 percent, down from 18 percent. In an environment of oversupply and falling developed-world malt consumption, what scope is there to reverse the decline in margins?

MD & CEO Alison Watkins
I reiterate my earlier comments that we’re very pleased with the performance of our malt business, and its competitive position in the global malt industry.

Malt margins are cyclical and influenced by factors including global malting capacity, the availability of barley and forex. Looking in more detail at the influence of forex, as part of our first-half investor presentation we have adjusted our malt EBITDA per tonne to a constant AUD/USD exchange rate of US$0.85 to the Australian dollar. After adjusting for forex, first-half EBITDA per tonne was $124 per tonne, $10 higher versus the prior half and $17 lower versus the pcp. What this shows is malt margins have softened year on year but the translation effect from a rising Australian dollar represents a material proportion of the reported margin change.

Consolidation in the global brewing industry is giving brewers additional bargaining power with their suppliers. However for us this trend is an opportunity, as our large geographic footprint, covering the UK, US, Canada and Australia, provides the opportunity for us to work with brewers on a global procurement model.

Another advantage we have comes from our grains expertise. We have particular expertise in the barley and malt markets in Australia, and now with the establishment of our Hamburg office we can offer similar expertise on these markets in Europe as well. This provides opportunities for us to work with global brewers to help them manage their supply risks and add value to their businesses.

While we expect further softening of malt margins in the short to medium term, we’re confident with our market position and competitive advantages.

openbriefing.com
GrainCorp’s malt production capacity stood slightly above 1.1 million tonnes as at the end of March. Since then you’ve announced the purchase of Kirin Australia, a 46,000 tonne per annum malt house in Western Australia, while your 86,000 tonne per annum Pinkenba plant in Queensland is currently being commissioned for commercial malt production. What proportion of your capacity expansion is contracted and what is the outlook for winning and retaining long-term supply contracts while spot market prices remain subdued?

MD & CEO Alison Watkins
Long-term supply agreements came into extensive use three or four years ago, at a time when brewers were concerned about the availability of malting capacity and barley supply. Beyond this, there are some extraordinarily enduring relationships in these businesses. While some buyers switch around, many focus on quality, consistency and continuity of supply rather than on price. For the 2012 financial year, we’ve sold around 600,000 tonnes of malt which is more than half our total capacity.

Some of the long-term contracts entered into three or four years ago are due to roll off in the next 12 months. We expect to renew some of them and are well advanced in doing that. Others may not be renewed, however continuity of supply will still be relevant for many of those customers.

About half of the Pinkenba plant’s capacity is contracted to a major domestic customer and the balance is destined for export. A high proportion of the capacity of our Arbroath plant in Scotland is contracted to a large whisky distilling customer. The Kirin malt house in Perth is fully contracted for the rest of this financial year and we’re confident of a similar result in 2012 because its location has advantages for certain customers.

A material proportion of our contracts are conversion-based contracts, where the barley price and supply risk is taken on by the brewer and we achieve a tolling margin. Global barley production is trending lower due to less planting. Whilst there remains sufficient barley to meet malting needs, we’re well placed to help brewers manage lower supply because of our geographic presence and knowledge of the world barley market.

openbriefing.com
Ports EBITDA was $55.5 million for the first half, up from $21.1 million in the pcp reflecting an increase in grain export volumes to 3.2 million tonnes from 1.5 million tonnes. What are the risks to meeting your upgraded full year export volume guidance, and how are you planning to continue to grow your port utilisation, including increasing your containerised grain export market share and your non-grain port capability?

MD & CEO Alison Watkins
We’re comfortable with our export grain handling forecast, but given that more than two thirds of the grain we handle is on behalf of our port customers, we are reliant on them continuing to execute sales. In the first half, our rail operations were disrupted by flooding and there was a lack of available trucks due to demand from other soft commodities. We expect the second half to be a lot more straightforward, although still a difficult execution task. We’ve successfully handled an additional 1.2 million tonnes of grain since the end of March, which takes us to about 4.5 million tonnes year to date and gives us confidence the forecast is achievable, barring something extraordinary.

We have a number of initiatives to grow our containerised grain exports, although these will take some time to achieve. Container exporting tends to be less profitable than bulk exporting, and is highly price competitive, so while we want to grow our sales, we don’t expect the upside offered by bulk exports.

Similarly, we want to continue to build our non-grain capability to help boost port asset utilisation. We’ve made significant investments in recent years, including the expansion of our Portland woodchip facility, where we expect higher woodchip export volumes over the next few years based on the volume of trees in the region coming to maturity. With increasing port capability we’ll also be able to do more of our own malt exports, and we have some good capability in fertiliser, including sheds at Geelong and Port Kembla dedicated to this task.

openbriefing.com
To what extent might the strong earnings from ports be an obstacle to winning approval for your wheat port access arrangements for the next three years, which have to be finalised for you to retain your bulk wheat export accreditation with Wheat Exports Australia beyond September 2011?

MD & CEO Alison Watkins
We don’t think that will be an issue. Looking across the cycle, our ports business has had some very lean years, including several port facilities that experienced years of no wheat exports. The business earns relatively low returns across the cycle so it’s comforting to be experiencing a good year.

openbriefing.com
Storage and logistics booked EBITDA of $43.0 million in the first half, up 23 percent, on revenue of $283.6 million, up 48 percent, reflecting a record harvest. Country receivals were 14.4 million tonnes, up from 7 million tonnes, and grain carry-over increased to 12.4 million tonnes from 6.1 million tonnes but margins fell to 15.1 percent from 18.3 percent. Did you sacrifice margin in S&L to drive business in ports and grain marketing? What impact is your investment in an additional 1 million tonnes of storage capacity expected to have on results in the second half and beyond?

CFO Alistair Bell
It’s not our practice to sacrifice margin in one area to assist another. We’ve seen extended disruptions to the recent eastern Australian harvest. Typically the harvest starts in Queensland then runs south into New South Wales and then Victoria. Work forces and equipment follow the harvest, but this year the protracted and disrupted harvest, with simultaneous harvest in northern New South Wales and northern Victoria, meant we were unable to employ the normal methodology. So while volumes have been large, variable costs increased and stayed in the business far longer than normal.

Additional tonnes harvested this year allow us to offset the negative effect of higher variable costs with earnings from additional storage fees. We’ve also taken the opportunity to invest in additional repairs and maintenance.

We prefer to look at the performance of the grains businesses on a throughput basis, where earnings include S&L EBITDA, ports EBITDA, and grain marketing profit before tax; and volumes include grain carry-in, country receivals and exports. Based on record first half throughput of 20.2 million tonnes, the combined grains businesses generated first half earnings per tonne of $6.13, up from the pcp’s $5.80 but down compared with $6.50 in the 2009 first half. Characteristics of the first half of 2011 included higher variable costs, which I talked about earlier, higher storage volumes and associated earnings per tonne, and deferral of outload fees and grain exports handled to future periods.

We built the additional 1 million tonnes of storage in the first half to handle the record crop. This additional storage was in the form of bunkers, located predominantly in southern New South Wales and northern Victoria. Utilisation of this additional storage will depend on the size of future crops.

openbriefing.com
How will the increase in grain carry-over tonnes impact current and future year earnings?

CFO Alistair Bell
Grain carry-over, or carry-out, is the grain held in our network at the end of the reporting period. To calculate carry-over, we add grain carry-in (i.e. grain carry-over from the last period) to country receivals and grain received direct to ports (ex farm and other competitor networks), then subtract domestic outload (from storage sites to domestic consumers), and export tonnage.

In terms of future earnings, carry-over tonnage generates higher storage revenue as the grain is sitting in the storage network for longer and storage fees per tonne increase for old season grain stored at the turn of the financial year. It also defers the recognition of S&L outload fees to the period of outload, and potentially generates earnings if the grain is handled through GrainCorp ports.

We anticipate significant carry-over of more than 6 million tonnes for 2011 (going into 2012), up from 2.6 million tonnes at the beginning of this year.

openbriefing.com
The grain marketing business had profit before tax of $26.0 million in the first half, up from $10.2 million, on the back of higher grain volumes and prices. How sustainable are earnings at this level?

CFO Alistair Bell
Our grain marketing strategy is to be an end to end supplier, buying grain from growers and selling it to consumers. Our marketing strategy takes managed risk with hedging positions against grain inventory. It’s hard to comment on future earnings in this business other than to say that our marketing policy looks to maximise margin on the available tonnage.

openbriefing.com
GrainCorp’s 60 percent owned flour miller Allied Mills contributed equity accounted profit of $1.6 million in the first half, down from $2.6 million in the pcp. To what extent did this reflect the flood damage to the Toowoomba flour mill? Can you provide an update on the Toowoomba facility and the outlook for Allied Mills?

MD & CEO Alison Watkins
Allied Mills’ financial results were affected not only by the closure of the Toowoomba facility due to the floods but also by the November rains that damaged wheat quality. With the availability of milling grade wheat constrained, prices ran up very quickly and Allied had to absorb more of this cost increase than we would have liked.

Allied is an important business for us, adding more value than just share of profits. In the first half Allied purchased around 200,000 thousand tonnes of grain from GrainCorp marketing. We also have a shareholder loan with Allied and receive more than $1 million in interest per annum. In addition, the innovative products Allied has introduced in its bread and cake mix lines keeps us in touch with end customers and their changing needs.

Allied management is still assessing the way forward with the Toowoomba mill. We certainly need to retain the capacity and expect the board of Allied to make a decision on the future of the mill soon. If we re-open the facility we’ll still face an outage of at least 12 months and as a result we’re now in the process of significantly reducing the mill workforce.

We’re comfortable with the net asset value of this business, of which our JV share is around $137 million, including the shareholder loan, or around 70 cents for each GrainCorp share.

openbriefing.com
GrainCorp had net debt of $755.6 million at 31 March 2011, up from $239.2 million at 30 September 2010. Excluding short-term financing for grain marketing inventory, core net debt was $227.6 million and gearing was 14.7 percent, up from 8.5 percent in the pcp. What were the main contributors to this increase in debt and in light of your growth plans over the next three years, what is the expected trend in gearing?

CFO Alistair Bell
As I touched on earlier, our strategy around core debt is to match our funding with corporate planning. Excluding the grain inventory funding, we use cash reserves to manage our working capital needs, which are seasonal: throughout the first half of the year we build up our working capital, principally receivables, so core debt increases. Through the second half, cash is generated from the reversal of working capital in line with the seasonal cycle, so core debt declines, ensuring end of year core debt below our 25 percent gearing target. With the relatively large harvest this year, receivables at the end of first half were a lot higher than in a low harvest year.

openbriefing.com
You’ve highlighted a number of initiatives aimed at increasing underlying full-year EBITDA by up to $40 million over the next three years via organic growth. How dependent is this on favourable seasonal conditions? What other opportunities are you considering to grow the business?

MD & CEO Alison Watkins
The strategic initiatives we’re implementing and the objectives we’ve set ourselves aren’t dependent on favourable conditions because they’re referenced to our view of a normalised year. Nevertheless, the size of the pay-off will depend on the kind of year we’re having: if we’re having an above average grain volume year we could deliver more; if we’re having a poor year we could deliver less. For example, one initiative is increasing efficiency across our receival network, including better coordination of grain receival, outload and logistics, so the pay-off we get from it will depend on the size of the crop, which is linked to seasonal conditions.

Other opportunities include potential acquisitions and other investments of capital. As normal for a company of our size, we’re always examining options for bolt-ons, particularly for our malt business, and in other downstream segments. The Kirin malt plant acquisition is a good example of the deals that are attractive to us: it required a relatively modest outlay but strengthened the strategic value of our network. We’re prepared to wait for the right thing to come along at the right time.

openbriefing.com
GrainCorp has announced a fully franked interim dividend of 15 cents per share, unchanged from last year, and a fully franked special dividend of 5 cents per share. This represents a payout ratio of 48 percent. What is the reason for declaring the special dividend and what is the outlook for the full year dividend?

MD & CEO Alison Watkins
Over the cycle we target a payout ratio of 40 to 60 percent of earnings. We also target being a sustainable dividend payer and for the reasons I outlined earlier, having the earnings stream from the malt business should enable us to do that.

Higher grain receivals, exports handled and marketed volumes were the major drivers of our record first-half earnings. We feel our shareholders deserve to be rewarded for this unprecedented grain volume year, so we’ve declared the 5 cent special dividend in addition to the 15 cent interim dividend.

Whilst we’re comfortable with our full year volume and earnings guidance, we continue to operate in a cyclical industry. In another six months we’ll have a much better understanding of our likely 2012 financial year operating environment including 2011/2012 eastern Australian crop conditions and new season world malting barley supply. Coupled with our second half 2011 financial performance, these outlook factors will be key to deciding the full year dividend.

openbriefing.com
Thank you Alison and Alistair.

For more information about GrainCorp, visit www.graincorp.com.au or call Reid Doyle, Investor Relations Manager, on +61 2 9266 9217

DISCLAIMER: Orient Capital Pty Ltd has taken all reasonable care in publishing the information contained in this Open Briefing®; furthermore, the entirety of this Open Briefing® has been approved for release to the market by the participating company. It is information given in a summary form and does not purport to be complete. The information contained is not intended to be used as the basis for making any investment decision and you are solely responsible for any use you choose to make of the information. We strongly advise that you seek independent professional advice before making any investment decisions. Orient Capital Pty Ltd is not responsible for any consequences of the use you make of the information, including any loss or damage you or a third party might suffer as a result of that use.