A Bumper Crop For ADM

By Stephen D. Simpson, CFA | February 03, 2011 AAA

When analysts can follow a company, to say nothing of an industry, for years and still routinely find their numbers wide of the market, that should say something about the likelihood of part-time investors figuring out the vagaries of the commodity markets. With global food and grain markets in turmoil, there should have been little doubt that it would impact the operations of Archer Daniels Midland (NYSE:ADM), but apparently even the most optimistic analysts underestimated ADM's ability to position itself to best advantage.

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The Quarter that Was
It is not often that a company that measures quarterly revenue in the tens of billions posts better than 30% growth, but that is what ADM did for its fiscal second quarter. Sales jumped over 31% this period, led by incredibly strong results in the company's Ag Services business (merchandising/handling of grain), but oilseeds and corn processing were hardly laggards with nearly 28% and 22% growth respectively.

For the most part, ADM also did an admirable job of translating that sales momentum into better profitability. Segment operating profits jumped 40% overall, despite an 8% decline in the oilseeds business. As Ag Services' profits nearly tripled, that would have easily covered up a lot of mistakes elsewhere ... had there been many. While the company's bottom-line earnings are a mess of charges, gains and non-operating items, the company still handily beat estimates.

The Good and Bad of ADM
ADM owed this strong quarter in part to the weather troubles in places like Russia. With Russia's harvest compromised, U.S. agricultural exports boomed and ADM clearly benefited from its middleman role in that trade. This, by the way, is also why the cash flow performance was not so good and was so different than the reported earnings - as a huge global trader with large origination, storage and delivery capabilities in the grain market, ADM can (and sometimes must) be opportunistic about building inventories, and that can wreak havoc on cash flow in any given period.

Elsewhere, the company was able to offset a decline in the the sweetners and starch businesses with strong performances in ethanol and bioproducts.

Unfortunately, even with this great quarter, segment operating profits were still just 6.5% of sales - a rather low margin in the larger scheme of things. That's just the nature of the business for companies that serve as middlemen and processors - whether it's Bunge (NYSE:BG), Corn Products (NYSE:CPO) or Cosan (NYSE:CZZ), none of these companies are likely to ever produce strong sustained margins. (For more, see There's Value In Bunge.)

The Bottom Line
ADM has never produced impressive free cash flow margins and likely never will. At the same time, agriculture seems like a pretty good place to be these days and a better option than food companies like Kellogg (NYSE:K), General Mills (NYSE:GIS) or Kraft (NYSE:KFT), all of which will have to figure out how to pass on higher input costs to price-sensitive shoppers. Surprisingly enough, for all of the talk around the agricultural sector and ADM's 6% jump on Tuesday, the stock looks reasonably priced for the time being.

If investors really want to play agriculture, names like Cresud (Nasdaq:CRESY), Adecoagro (Nasdaq:AGRO) and Sprott Resources might be more appealing. Investors should remember that this is a tough sector, though, and even experienced watchers miss a lot of the major turns. Consequently, approach it with caution and patience or not at all. (For more, see 5 Agriculture Stocks To Grow With.)

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