my 2 cents worth

This is how I view Graincorp:

After digging up some research from various places (plus some of my own research), this is my 2 cents worth on GNC. In order to put things into perspective, I have attached a comparison table, showing the current situation for GNC vs. ABB Grain prior to the Vittera bid:




The table clearly summarises a huge disparity between ABB and Graincorp. I do agree that ABB is based primarily in S.A whereas GNC is based on the East Coast. However, the location itself does not guarantee rain. All things being equal, it is evident we have a huge valuation disparity between GNC and ABB. GNC has more than twice the number of silos and nearly twice the malting capacity of ABB, yet GNC is valued at roughly the same Enterprise Value as ABB (prior to the Viterra bid). Not to mention, GNC has a 60% stake in Allied Mills too!!

I also need to point out the metrics I have used, were taken before the Viterra bid, hence you can add another $0.5bil to the Enterprise value of ABB if you want to consider the financial metrics on the basis of Viterra's takeover. I am trying to keep a level playing field by justifying GNC's valuation as a stand alone business, rather than a takeover candidate. We can always dream up our own takeover valuations, but that is not what I aim to do.

Please note that ABB had 3 successive downgrades before the Viterra bid and it seemed Viterra paid up dearly for ABB. However, given the strong 2009 season in South Australia this year, Viterra's decision seems justified.

There is a lesson to be learnt: Corporate investors/players understand the nature of the agriculture sector. They invest into businesses for the long haul and do not place too much emphasis on a single season. Yes. There may be pressure if you string together a series of drought affected years, but on the whole, weather is highly un-predictable and after a series of drought years, you tend to get some decent years too. I am not trying to predict the weather. Rather, I'm stating a fact that the odds tend to even out over time.

So, why has GNC's share price been depressed over the past 2 months? The reason is simple:

1) The acquistion of UMH is EPS dilutive due to the strong A$. The acquisition was seen as a strategic buy, but many investors were of the view that GNC overpaid for UMH. This is not surprising given UMH was sold out of private equity hands. Whilst this may seem like a bad acquisition right now, who knows what it will look like in 12 months time (just take a look at Viterra's ABB acquisition).

2) Due to the various GNC rights issues and placements, there has been strong stock overhang. This needs time to clear. There is no silver bullet to this stock overhang. It just needs time. Added to this, the farming community is a huge shareholder in GNC. They are mostly retail investors and some might just trade the stock at any given time based on their sentiment. Remember they let 20+ million shares lapse. These were $5.65 shares when GNC was trading at approx. $7.00!

3) Expectation of a bad season for GNC on the back of continued drought conditions in certain parts of NSW & QLD. This expectation together with the huge stock overhang provided ammunition for traders/ investors to short GNC. Whilst the overall "borrowed position" in GNC is not huge, there seems to be approx. 20% of GNC's being shorted (on a daily basis) over the past few weeks. However, be forewarned that this does not mean a thing as shorters can close out their positions the next day. In order not to spark controversy about spreading rumours, I have attached a table of short sales in GNC over the past 7 trading days. The only days when GNC were not shorted heavily was during the "profit downgrade" announcement, which I presume caused some shorters to lock in profits (closed short positions).






4) Rain arriving at the wrong time harming grain grades. I see this is a minor issue as the main revenue driver for GNC is volume, not grades. Yes, they may clip a smaller margin for lower grade grain, but I doubt it is significant in the scheme of things.


That said, I am not worried about GNC, neither should any investor with a longer term horizon. These are the reasons why I am long term positive on GNC:

*-* At current price levels, we are trading at an EV/EBITDA multiple of 8.0x, which is good value. Additionally, any EBITDA number above $180 mil will push the multiple lower. (e.g. if GNC reports an EBITDA of $210 mil, EV/EBITDA = 6.9x) Therefore, this was the main reason why I mentioned not to short under $6. The only reason you would short GNC around these levels is if you believe GNC will have a worse year in 2010 than in 2009. However, that would be a gutsy call.

*-* Whilst there is talk that GNC will write down some of their assets (which is likely), the important issue to note is the replacement value of their infrastructure. Are 260+ silos, 9 ports, 60% of Allied Mills & malting houses worth more than $1.45 bil? I would think so. If you were to replicate these assets from scratch, I honestly believe you need more than $1.45 bil. Given Viterra paid approx. $2 billion (including debt) for ABB's 110 silos, 7 ports and malting capacity which is half that of GNC, I can safely say I am assured as a GNC shareholder.

*-* This brings me to my next point on excess assets. There are a couple of ports that GNC control which are really underutilised. If needs be, these can either be sold or re-vamped to unlock potential income streams through the export of other commodities like coal, Cu etc.

*-* GNC has a much better balance sheet now. They are not overgeared and they have a more stable revenue stream due to UMH's contribution.

*-* Management are being proactive in stripping out costs (i.e. closing merchandising division)


There you go. That's my 2 cents worth. It took me a while to compile the note. Whilst I have a positive view on GNC, I am definitely open to bearish comments and sugesstions. What we need to do is invest on facts and hopefully once the overhang clears, GNC can re-rate. Good rains next year will definitely help too.

That's all for now. Have a safe & Happy New Year. Keep the comments coming.

Happy investing.