Another crack at GrainCorp by ADM appears inevitable

A significant plunge in the Australian dollar to US72c from US92c, together with a notable softening in the share price – plus the likelihood of a more receptive hearing from a Turnbull-led coalition government – means US food processing giant Archer Daniels Midland (ADM) has more reason to take a second tilt at GrainCorp Ltd (ASX: GNC) since its initial $3.4 billion takeover bid was rejected outright by an Abbott-led government two years ago.

GrainCorp’s shares tumbled 22% immediately following revelations the government had rejected ADM’s offer, and at $8.20 the share price is now trading 31% below ADM’s original takeover offer at $12.20 a share, which subsequently jumped to $13.20.

While GrainCorp’s managing director Mark Palmquist has not allegedly talked with ADM about a new takeover bid, this seems unlikely given that its 19.85% control of the company would give it a lot of clout at board level.

A future offer does seem to have an air of inevitability about it, and ADM has openly admitted the change of political leadership in Australia had boosted its chances of winning control of the local grain handler. Interestingly, the market seems to agree having pushed GrainCorp’s share price up 9% on the news of Turnbull’s prime ministership.

It’s no secret that ADM has been eye-balling GrainCorp to compensate for its under-exposure to the huge China market. However, given the sheer volume of logistics and market challenges currently confronting GrainCorp management, ADM’s next offer may not have the same level of takeover premium that was embedded in their initial offer.

GrainCorp operates on a September year-end, and for the six months ending March 31 the company reported a drop in operating net profit after tax (NPAT) to $35 million.

In response to the drought conditions in key growing regions of Victoria, NSW and QLD, GrainCorp has cut it profit forecast, and on Melbourne Cup day warned that full year operating NPAT would be between $45 million and $60 million. The nation’s biggest-listed agribusiness also cut its underlying earnings forecast to $235 million, which is also at the bottom end of previous guidance of $240 million to $270 million.

To put these numbers in context, in 2013-14 GrainCorp reported underlying profit of $95 million, down from $175 million during a bumper crop year in 2012-13.

Equally problematic for an ‘ADM-controlled’ GrainCorp is the company’s over reliance on Australian east coast grain crops and the need to originate more grain from offshore to successfully compete with powerful rivals like Cargill, Glencore and Bunge that have large global distribution chains.

Given that El Nino weather conditions could weigh even more heavily on Australian earnings in 2015-16, GrainCorp’s efforts to become more diversified globally are encouraging. It’s started to reduce its reliance on local grain crops by originating grain offshore through Saxon Agriculture in Britain and its desks in Hamburg and Calgary. Due to recent malt and oils acquisitions, its grains business accounted for 32% of its earnings last year, down from 87% in 2009.

To further shake the grip of east coast drought on its business, the company is currently spending around $500 million on growth projects, which include the expansion of its US malt operations.

While GrainCorp’s long term cash flow relative to reported profit is strong, earnings per share (EPS) which has experienced good growth over the last five years, is expected to soften; with EPS of $0.22 in 2015 expected to increase to $0.39 and $0.53 in 2016 and 2017 respectively.

While GrainCorp doesn’t look particularly cheap, based on a 2016 P/E of 37.86 times, the great unknown is what sort of premium ADM will bring to the bidding table second time around. Given that it has deep pockets with which to further fund GrainCorp’s badly needed global diversification, a future ADM takeover should reward shareholders.

But you need to buy GrainCorp on fundamentals rather than the likelihood of a future takeover and with further profit warnings likely, the share price could come under further pressure.