The Graincorp Ltd (ASX: GNC) share price is the best performer on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index this afternoon as investors cheered news that the grain handler had signed a deal with an insurer to smooth out its volatile earnings.
The Graincorp share price surged 4.9% to $8.09 in after lunch trade, which puts the stock on top of the leader board with the Magellan Financial Group Ltd (ASX: MFG) share price, Beach Energy Ltd (ASX: BPT) share price and Lynas Corporation Ltd (ASX: LYC) share price taking the second to fourth spots, respectively.
Shareholders in Graincorp will be hoping that the company has turned a corner as its shares have collapsed over 15% in the past three months when the broader market is up by nearly 3%.
Controlling earnings volatility
Adverse weather, particularly along the east coast of Australia, has hurt sentiment towards Graincorp, although today's 10-year agreement with White Rock Insurance will help to address the unpredictable earnings pattern of the company.
"As previously announced on 4 April 2019, the purpose of the Contract is to smooth GrainCorp's cash flow and earnings across volatile east coast Australia grain harvests," said Graincorp in its ASX statement.
"As a result, the Contract will have several benefits for GrainCorp and its shareholders including a reduction in cash flow volatility, particularly in periods of severe drought."
How the risk management agreement will work
The contract will start in the new financial year and will give Graincorp the right to receive $15 per tonne if annual production falls below 15.3 million tonnes in any given year, subject to an annual maximum of $80 million.
However, Graincorp will have to pay $15 a tonne to White Rock if annual production exceeds 19.3 million tonnes, although annual payments will be capped at $70 million.
Over the 10-year period that the agreement covers, the payments to either party will be limited to $270 million in total.
"Excluding the Production Payments, the total pre-tax annual cost of the Contract to GrainCorp is expected to be less than $10 million (including associated financing costs)," added the company.
That sounds like a reasonably modest price to pay to help manage the risks associated with the company's unpredictable cash flows.
All figures are in Australian dollars and the contract remains in force even if there is a change of control at Graincorp (meaning a takeover).
