Friday, October 2, 2015

Notes on Archer-Daniels-Midland (ADM)

ADM is one of the largest grain processors in the world. The 4 major segments are 1) Agricultural Services - which store/transport/trade commodities, 2) Corn Processing – this turns corn into sweetners and starches. Importantly this segment also includes ADM’s ethanol operation. 3) Oilseeds Processing – where ADM does crushing & origination. Soybean related products are key here. 4) Wild Flavors – a new segment that does specialty food ingredients.

Why am I looking at this in the first place? My bull hypothesis is as follows: 1) As a processor that takes soybean and corn as inputs, weakening commodity prices should help ADM’s margins. 2) Despite the cyclicality, over the long run demand for ADM’s products should be very stable. 3) As the world consumes more proteins, ADM’s volume should grow at higher than GDP.

I also think ADM is a good company to track due to availability of related data. I can monitor data from commodity futures and USDA to constantly update, prove, or disprove the above hypothesis. Things like soybean crush spread, ethanol prices, currencies are available in real time and inform one’s view on ADM.

Segment Contribution and Drivers

Here is a quick rundown of each segment’s contribution to operating income (last twelve months), as well as their drivers:

Oilseeds processing (42% of operating income)

  • The key grain here is soybeans so I compared current soybean crush spread against historical levels. Current industry crush spreads (see appendix at the end of the article) are near all-time high but declining, which points to downside for ADM. My first bull hypothesis – that declining commodity prices should help ADM’s margins –thus appears already played out and in fact fading. 
  • However, ADM’s oilseeds margins (in terms of $ per ton processed) were stable the past few years even as industry crush spreads fluctuated. My guess is ADM will be relatively stable when industry spreads decline as well. But I certainly would not count on much upside from margin expansion. 

Corn processing (24% of operating income)

  • Operating profit from ethanol was down ~$220mm in 1H2015. Some of that will be recoverable as ethanol margins recover, creating upside in the segment.
  • However, it seems that analysts are already building in ethanol price recovery (perhaps due to expectations of oil price recovery). Consensus has EPS of 3.08 and 3.40 for 2015E and 2016E. This 10% growth will be hard to come by without ethanol at least stabilizing. Besides, the days of $100 oil are over and ethanol margins are unlikely to fully recover to past levels.

Agricultural services (27% of operating income)

  • This is storage/transportation/trading…etc. Historically profit here relies on level of US exports, which is a function of how competitive US is versus say, Brazil. With USD strong and the Brazilian real weak, this segment is unlikely to see much advantage. The near upside here is 1) El Nino somehow destroys Brazilian crops, and 2) US has a great crop. 

Wild Flavors (6% of operating income). This could be a growth area for years to come but not enough to offset the importance of the other segments.

Upside Assessment and Current Action Plan

Looking through the main segments, I just don’t see much earning upside beyond those already factored into the consensus. Thus returns will have to come from multiple expansion, which will likely happen if ethanol stabilizes and exports don’t fall apart. In terms of valuation, right now it trades at 11.9x TTM vs 10yr median of 13.3x. That’s a 12% upside from recovery in multiples. In terms of downside, soybean crush margin can weaken, ethanol stabilization can come later than expected, and Brazil and China can enact policies that hurt US competitiveness and export levels.

This is not enough for me to get in. For now I will sit on the sidelines and wait for fundamentals to get better.

Appendix: Historical soybean margins

I calculated these from front month futures data and the formula Soybean crush = soybean oil (in cents/lb) * 0.11 + soybean meal (in $/short ton) * 0.022 - soybean prices (in $/bushel).  The crush spread is still higher than historical because soybean meal is a larger contributor than soybean oil, and soybean meal prices has not came down as much as the others.

historical soybean crush spread ($/bushel)

soybean complex historical data

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