ADM Working Through A Lull

By Stephen D. Simpson, CFA | May 04, 2012 AAA

One quarter ago, I opined that Archer Daniels Midland (NYSE:ADM) looked like a good stock for patient investors. With the stock having doubled the return of the S&P 500 over that brief time period, so far so good. ADM's business is always going to be a volatile, commodity-driven enterprise, but the company does earn long-term economic returns on an asset base that would be extremely difficult (and expensive) to replicate.

For Q3, Less-Bad Passes for Good
By no means did ADM have a strong fiscal third quarter, but the results were not nearly as bad as analysts had projected. Revenue rose 1%, as mid-teens growth in both oilseed processing and corn processing were offset by a small (1%) decline in the large agricultural services business.

Profits were likewise pretty miserable. Gross margin fell one point (but nearly 20%), while operating income plunged more than 20%. Despite the strong revenue growth, the processing businesses each saw greater than 20% segment profit declines, while ag services profits were up modestly. Awful as that may look, the company's operating profits were 25 to 50% higher than most analysts had estimated.

Better Demand and Better Leverage
ADM's results were helped, in part, by better results in oilseeds, fueled by stronger meal tied to tight supplies in South America. While ADM seemed to have a better quarter in the U.S. than Bunge (NYSE:BG), both companies pointed to very weak conditions in Europe and strong performance in Brazil.

SEE: How Globalization Affects Developed Countries.

ADM also seemed to get a relative boost in its corn business from ethanol. Incremental ethanol spot margins are not that good right now, but the company is getting better leverage out of its existing infrastructure. Higher prices in sweeteners seem to be sticking, but a glut in sugar is raising the risk of substitution for companies like ADM, Corn Products (NYSE:CPO) and Cargill, but also boosting ethanol producers like Cosan (NYSE:CZZ) that use the cheaper sugar instead of corn.

Better Times Coming, but What About the Growth?
Early planting numbers suggest a huge corn crop in the U.S. this year, and that should bode well for ADM. A large corn crop means more demand for the company's ports, silos and ships (Ag services), and I would argue that recent bid from Glencore to acquire Viterra supports the long-term thesis on grain handling as a business.

It's also worth wondering how ADM's renewed focus on capital efficiency and economic returns will play out over the long term. The company ended its venture with Metabolix (Nasdaq:MBLX) in bioplastics and seems to be more interested in concentrating on its traditional handling and processing businesses.

That's all well and good, but at the same time DuPont (NYSE:DD) is getting more active in biomaterials, including its move to acquire 100% of Solae from Bunge. Given DuPont's solid reputation over the last decade or two in identifying future growth markets and positioning itself accordingly, it's worth asking if ADM might have been too hasty or may be too conservative in its view of its business.

The Bottom Line
The nice move in ADM shares has taken some of the easy gains off the table, but I can still see a cogent argument for holding on to these shares today. Should the shares drop below $30 again I would consider getting more aggressive on the name, but I'd rather look for ideas with a little wider margin between fair value and today's price.

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