Thursday, September 30, 2010

ADM Has Upside Grains

AS WORLD POPULATIONS GROW, they will require more food and fuel. With its portfolio of food ingredients, livestock feed and biofuels,  Archer Daniels Midland may well be the company supplying them.

Shares of the grain-processing powerhouse have already gained ground this year as shortages caused by bad weather in Europe and Canada pushed up prices for corn and wheat. But analysts say ADM (ticker: ADM) still has plenty of growing to do before harvest time, which also reflects its modest current valuation.

The stock trades at only 10.6 times forward earnings, below the 11.4 times for competitor  Bunge  (BG). Analysts argue ADM should fetch a premium to Bunge, based on its stronger average return on assets over the past three years.

ADM's grain storage and export businesses should continue to benefit from elevated grain prices. Two pending decisions by regulators on approving higher ethanol blends for cars could be additional catalysts over the next few months.

ADM recently finished a spate of capital projects related to its ethanol and bioplastics businesses, leaving more cash available to buy back shares. The shares also carry a 1.8% dividend yield, rounding out the solid picture.

To be sure, higher corn prices are a negative for ADM's high-fructose-corn-syrup business, which has already been battered by the perception of the sweetener as unhealthy. The volatility of commodity prices and ADM's complex hedging also make projecting the company's quarterly earnings particularly difficult, leaving room for misses. But analysts contend corn syrup isn't going away, and fans of ADM say it is best evaluated on a longer time line.

"We think that this is a tremendous long-term holding," says D. Tysen Nutt Jr., a senior portfolio manager at Delaware Investments, which owns ADM shares. "It's a great company at a reasonable valuation that is going to be part of this movement toward greater demand for food as economies and populations grow."

Nutt and his team at Delaware are more bullish on commodities than they are on stocks and see ADM as a way to play that. They estimate the shares could have something on the order of 50% price appreciation over the next three to five years.

Weather, as it often does, has played havoc with commodity prices. A drought in Russia, a key European supplier, and wet weather in Canada pushed wheat prices up more than 45% since the end of June. Corn prices rose more than 35% over that period on speculation that hot, dry weather damaged crops. Prices for both grains have eased recently, but Credit Suisse analyst Robert Moskow says there could be more upside for ADM if the arbitrage opportunities for the grain shortage in Europe play out.

An expansion of its oilseeds (soybeans, cottonseeds, sunflower seeds, etc.) business, now underway, could prove even more significant for ADM's future earnings growth. During its fiscal-fourth-quarter (ended June 30) conference call, management said that it would increase oilseed capacity by 7% to 10% annually over the next five years in order to meet growing demand.

A new oilseed facility in Paraguay, slated to come online in fiscal 2012, will contribute one percentage point of that growth. The rest may come from acquisitions, Moskow says. "I think that any acquisitions they make would probably be accretive, and this is a business that they've shown that they're growing and doing very well in," he says.

News on the ethanol front could propel the stock in the next two quarters. The Environmental Protection Agency is expected to make a decision in mid-October about whether a higher-ethanol blend of gasoline, known as E15 (15% ethanol, 85% gasoline, versus the current standard of 10% ethanol, 90% gasoline) is safe for vehicles made since 2007. The EPA is expected to rule on cars made since 2001 in December. Analysts say the rulings are likely to favor ethanol producers.

"There's been precious little proof that E15 would be a problem for any car," says Paul Resnik, an analyst with Olympia Capital Markets. But, he adds, the auto industry sees the fuel-mix change as a no-win situation and has resisted it.

While ethanol isn't ADM's bread and butter, headlines on that front would likely affect the stock. And ethanol isn't all hype: ADM has invested $2.3 billion in capital projects related to ethanol and bioplastics, suggesting meaningful growth on the horizon.

Assuming a return of just 6% on the $2.3 billion investment, the company could have another 15 cents per share in earnings by fiscal 2012, says Moskow of Credit Suisse.

The one sticking point for ADM may be its corn-syrup business. Operating profit for the sugars and sweeteners category fell $30 million, to $119 million, in the fiscal fourth quarter, driven down by the increasingly pervasive idea that corn syrup is less healthy than other sweeteners. Many scientists say it's no worse than sugar, and it costs about 40% less.

Moskow and others say corn syrup isn't about to disappear, and indeed the industry may actually be able to raise prices by December.

The corn-syrup flap aside, ADM should help satisfy investors' hunger for steady returns as the company provides food and fuel to a growing world.

barrons.co

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