A quarter ago I was pretty positive on the shares of Archer Daniels Midland (NYSE:ADM). This was not so much because I saw a dramatic turnaround coming in the business, but because I saw it as a good long-term value. Although fiscal second quarter earnings show that there are still some very real challenges, investors really haven't hurt themselves by owning these shares as a long-term value.
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Another Difficult (and Complicated) Quarter
All in all, the fiscal second quarter was not very good for ADM. Reported revenue did rise 11% and the company posted gaudy-looking growth in oilseeds processing (up 28%) and corn processing (up 29%), while the huge ag services business saw a 1% sales decline.
The problem, though, was profitability. ADM earnings were a maze of charges and items, so here's the basic rundown. Oilseeds profitability was down significantly (margin of 3.4% versus 5.3%) on weak crush margins. Corn processing profitability was down significantly (adjusted margin of 6.4% versus 16.1%) on higher corn costs, while reported numbers were hurt by charges related to ending the partnership with Metabolix (Nasdaq:MBLX) in bioplastics. Ag service margins were also very weak (1.4% vs. 4%) on weak international merchandising performance. (For related reading, see Analyzing Operating Margins.)
At the bottom-most line, ADM's "economic profits" were on the order of 64 cents a share - definitely below estimates, but perhaps not as bad as feared.
Things May Not Get Easier
Unfortunately, the near-term outlook for ADM is not radically better. The best news for ADM may be in the ethanol business if oil and gasoline prices continue to rise. There's also a decent chance that ADM, Corn Products (NYSE:CPO), and Cargill will see higher corn sweetener prices. While companies like Coca-Cola (NYSE:KO) and Pepsico (NYSE:PEP) are still threatening to reintroduce sugar, high-fructose corn syrup is a vital ingredient in processed food and the industry is looking for double-digit price increases in 2012.
Now for the bad news. Although ADM and rivals like Bunge (NYSE:BG) and Cargill are not foolish competitors, the reality is that the oilseeds processing industry is running at around 80-85% capacity and there's ongoing pressure on margins. In corn, increased supply for a host of products is likewise pushing down the full-year outlook. Against all of this too, is a backdrop of weak consumer demand that is capping both volume and price potential in a wide range of products.
ADM Getting Smarter
Still, all is far from lost for ADM. There's not much that the company can do about the current weakness in its ag processing; this is just the nature of the business. What ADM can do, though, is get smarter about its costs and capital expenditures and that looks like what's happening. None of this is exciting or sexy, but that's not what pays in the long run in this industry.
The Bottom Line
ADM shares still look pretty appealing for patient investors. Though I'm not much into technical analysis, it does look as though the shares tested a long-run trendline back in October 2011 and passed the test. Other metrics (like price to tangible book) suggest that these shares are about as cheap as they get.
When looking at the cash flow model, I have little expectation of significant growth. Instead, I project just 3% compound growth for the next decade and a market-matching discount rate. At those numbers, these shares could have the potential to rise as much as 30% over the next 12-18 months. Add a better than 2% dividend yield and share buybacks, and this looks like a solid value/turnaround idea. (For related reading, see Digging Into The Dividend Model.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.