The GrainCorp Limited (ASX: GNC) share price is up 4% this morning following a new contract that is designed to smooth earnings for the next 10 years.
About GrainCorp
GrainCorp is the largest Eastern Australian grain storage and transport network. It has seven bulk grain ports, it’s among the top five global malt producers and it’s Australia’s largest integrated edible oils business. It exports its products to more than 30 countries. As of 2016, it has been operating for over 100 years, making it one of Australia’s oldest companies.
New Contract
GrainCorp announced this morning that it has secured a 10-year contract that was previously announced to the market on 4th April 2019. This contract is designed to manage the risk that comes with the volatility of eastern Australia winter grain production.
The contract, with White Rock Insurance Ltd, will smooth GrainCorp’s cash flow and earnings during east coast Australian grain harvests.
The agreement states that a fixed payment of $15 per tonne (the “production payment”) will be made for each tonne of actual east coast winter crop production, with GrainCorp receiving the production payment if production is below 15.3 million tonnes or paying the production payment if production exceeds 19.3 million tonnes.
GrainCorp’s payments are capped at $70 million per year, while White Rock’s payments are capped at $80 million.
Excluding production payments, GrainCorp expects the annual pre-tax cost of the contract to be less than $10 million.
Why is this so Important?
The effect that this contract has is that it smooths GrainCorp’s earnings for the next 10 years. The industry that GrainCorp operates in can be extremely volatile due to weather conditions so the ability to stabilise earnings is crucial. This is essentially a long-term hedge.
Stable earnings will enable GrainCorp to better forecast future earnings and cash flows, which is useful to both the company and investors trying to value the business.
GrainCorp’s CEO Mark Palmquist highlighted the effects of the contract.
“The Contract will smooth GrainCorp’s cash flow and allow for longer-term capital allocation and business planning through the cycle,” he said.
Is GrainCorp a Buy?
This is certainly good news for the company and it will make valuations easier for investors, but the contract only applies to a small portion of GrainCorp’s operations.
GrainCorp will be a business I’ll be watching more closely, but right now, I’d rather invest in one of the businesses mentioned in the free report below.
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Disclosure: At the time of writing, Max does not own shares in any of the companies mentioned.
