Investigating A Corny Subject (ADM, CPO, CAG)

By Dean Lundell | July 25, 2007 AAA

The problem with being in a commodity business is that you have to find a way to differentiate your company from all the others. You must figure out what makes you better. What value can you add? The corn commodity business is characterized by razor-thin margins, and some firms survive better than others. Let's take a look at three companies in the corn processing business to see what pops up.

Two Sides of the Same Coin
Archer Daniels Midland (NYSE: ADM) with a market capitalization of almost $24 billion and sales over $41 billion, is one of the largest oilseed processors in the world. It is also the largest corn processor and ethanol producer. Yet again, ADM has shown us all why higher commodity prices do not necessarily translate into higher returns for investors. Although ADM has been able to pass along some prices on its products, in the end the company is a price taker on both sides of the equation; what they pay for raw material and what they can get for finished product.

The company's saving grace has been the booming demand and record sales for ethanol. This is good because margins and profits have been pressured in oilseed processing with operating margin actually losing 50 basis points to 4.9%.

ADM is protected by a 54-cent tariff on ethanol imports from Brazil and also benefits from the tax incentives that oil refiners get for using ethanol. Despite government protection, ADM's share of the ethanol market has declined to 25% from a high of 60%.

ADM derives 90% of its revenue from food processing, but it seems that ADM wants to be seen as an energy company. Given the thin margins and profits in food products, and a protected market in ethanol this seems like a reasonable assumption. But, how long ADM can enjoy this protected market is anyone's guess.

A Sweet Deal
Corn Products International (NYSE: CPO) is fraction of the size of ADM with a market capitalization of about $3.3 billion and sales of roughly $2.77 billion. However, it is one of the world's largest refiners and derives 55% of its revenue from sweeteners in one form or another, 22% from starch products and the balance in co-products. Last year roughly 19% of CPO's revenue came from the food industry, 18% from soft drinks, 11% from brewing and 10% from animal feed markets with the remainder going to other uses in the industrial market.

Although North America accounts for 61% of the company's sales, CPO does business in 60 other countries. While this geographic dispersion cushions CPO somewhat from a volatile commodity market in North America, it also increases their geopolitical risk at the same time. (For more, see What is political risk and what can a multinational company do to minimize exposure?.)

While the price of CPO's shares has clearly outpaced its much larger rival ADM, CPO must do better if it hopes to defend that record. Its 10.8% return on equity is indicative of that need. The company has several goals in mind to achieve this: operate at maximum efficiency, expand into emerging markets such as Asia, enter into partnerships and alliances to offer value-added products and supplying high-value food ingredients

Do you want Fries with That?
Conagra Foods (NYSE: CAG) has a new management team in place and is making successful transition from a low-margin commodity processor to a high-margin, value-added brand manager. Examples of its more visible names are Healthy Choice, Banquet, Egg Beaters and Parkay. The firm is also the largest supplier of french fries to McDonald's (NYSE: MCD) and Sysco (NYSE: SYY). Perhaps Conagra's corporate strategy is playing both ends against the middle.

In any event, Conagra has rid itself of low-margin product lines and is focusing on brand management. The company hopes to make up for a year of less-than-enthusiastic management by investing in marketing and product innovation. This strategy worked well for its leading product franchise Healthy Choice.

With $13.3 billion in market capitalization and $11.7 billion in sales, CAG has made good progress, but there is room for improvement. The company's earnings growth has hovered around 10% for the past couple of years. Its 25% gross margin translates into a fairly thin 5.4% net margin and a 13.5% return on equity; this means the company is going to have to make more progress on its vertical integration strategy.

Expectations
Price-earnings multiples (P/E) are a generally accepted way of measuring the volatility of a stock. They are also the market's way of expressing an opinion about its expectations. There is certainly a need for commodity-based businesses to differentiate its product and service away from "plain vanilla" and towards more value-added products. Corn Products International has done this, as have Conagra and Bunge (NYSE: BG) Bunge, CAG and CPO all trade in the low 20s for P/E, while ADM trades at about 15-times. Perhaps the market isn't expecting much from them.

For more on Bunge, check out Bunge's Negative Cash Flow A Red Flag.

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