GrainCorp swats away an ADM annoyance

Alison Watkins and her board would have felt quite comfortable and confident in rebuffing the $2.7 billion proposal from Archer Daniels Midland for GrainCorp after producing yet another stellar result and that confidence was validated by the sharemarket's response.

Despite the rejection of an $11.75 a share proposal that was pitched at a 33 per cent premium to GrainCorp's share price before ADM revealed its interest the market pushed GrainCorp shares even higher, to about $12.20, after the group revealed it had told ADM this morning that its proposal materially undervalued the company.

It didn't hurt that Watkins was able to unveil a 19 per cent profit increase, to $205 million, and confidently outline plans to lift earnings before interest, tax depreciation and amortisation by $110 million over the next four years. GrainCorp's EBITDA in the latest financial year was $414 million so the prospective structural uplift in underlying earnings is significant.

The market's ability to digest the rejection of the ADM approach so easily, moreover, suggests that it not only likes the business model Watkins has developed and the momentum it has been producing but subscribes to her view that GrainCorp is both a highly strategic player within a global agricultural sector with tremendous growth prospects but one with the ability to capture its fair share of that growth.

The nature of the ADM approach – an indicative, non-binding, highly conditional proposal – is one that boards can readily reject, particularly from the platform of a strongly-performing company.

As Watkins said on Thursday, since the deregulation of the wheat industry began GrainCorp has been transformed from a company with a $500 million market capitalisation six years ago to one with a $2.8 billion market capitalisation.

In the past three years it has significantly outperformed the market. It delivered a total shareholder return of 36 per cent in the year to September and returns on equity averaging 11.2 per cent over the past three years and rising towards the mid-teens this year.

With harvesting under way and what appears to be another strong year for grain growers in train, its own business improvement program and the benefits of the two edible oils acquisitions it made this year yet to flow, GrainCorp does have a good story to tell.

Despite the rejection and that growth story, however, Watkins would know that ADM isn't simply going to disappear with its tail between its legs. In a departure from the private equity tactics it has emulated, ADM began its tilt at GrainCorp by acquiring a 14.9 per cent stake.

Apart from signalling that there were GrainCorp shareholders willing to sell at $11.75 a share – ADM could have acquired more if not for the 15 per cent ceiling without Foreign Investment Review Board approval – it means GrainCorp will have ADM on its register for some time.

Both companies are very aware that agribusinesses are subject to cycles and hostage to the weather. While it appears GrainCorp is in something of a sweet spot in terms of the growing conditions in recent years one poor season could create vulnerability if ADM hangs around. ADM appears to believe that season could occur in 2014.

In an industry which has been consolidating rapidly and globally GrainCorp is highly strategic. It is the dominant east coast grain handling business, has strategically significant positions in wheat, barley and canola, has strong market shares in malt, flour, canola and edible oils and operates seven of the eight bulk ports in eastern Australia.

It would appear a reasonable assumption that all the international players with global ambitions within an industry that, due to rising living standards in Asia is set to experience strong long-term growth rates, would have looked closely at GrainCorp.

It would also appear reasonable to assume that ADM chose its moment, in the knowledge that GrainCorp was in the midst of a period of strong performance, with an eye to its competitors.
For a variety of reasons – China's change of leadership, their financial capacities and competition policy hurdles – most of the obvious candidates are handicapped for the moment.

By getting its foot on the GrainCorp register, ADM has buttressed its position in the knowledge that it either has to put a lot more money on the table to get GrainCorp's support for an offer or sit there patiently waiting for the inevitable poor season.

If GrainCorp can keep ADM at bay it does have terrific long-term prospects. It has unique assets and strong market positions in key commodities – it has positions in segments representing 35 per cent of the world's global traded grains and oilseeds – which it has demonstrated it can build on, with increasingly diverse and therefore less volatile income streams.

With Watkins having said on a number of occasions that she expects the global trade in the group's core grains to double by 2050 and canola oil exports having trebled in the past decade and experiencing continuing strong demand growth in Asia there is an exciting growth story for Australian producers, and GrainCorp, given Australia's agricultural production and its proximity to the growth markets. GrainCorp is the last of the meaningful listed agricultural companies in this market.

The problem for Watkins and her board is that ADM understands that too and is likely to have a longer-term perspective than most of GrainCorp's institutional shareholders, for whom 12 months is often the long term. If ADM doesn't come back soon with an increased "offer," the pressure on Watkins to maintain the group's performance regardless of seasonal conditions will continue and, indeed, mount.