During the course of 2012,investing in agriculturalstocks proved
to be tricky. One of the nation's worst droughts on record up-ended
thebusiness model of so many companies as crops wilted and cattle
were brought to premature slaughter.
Yet there were a fewbeneficiaries of the drought.
Back in July, BG) and
Ingredion (Nasdaq: INGR)
would prosper, and in that time, they've scored gains of 22% and
Back then, I looked at another major agricultural play, but
sensed that it was too soon -- perhaps the back half of 2013 and
into 2014 was the time to really focus on this company, I
Warren Buffett has other ideas. He's already loading up onshares
Archer Daniels Midland (
, acquiring 6 million shares in the fourth quarter of 2012 at an
average price of $27. Shares have risen a bit further since, and
show signs of breaking out of a longstanding trading range.
Though theturnaround for Archer Daniels is severalquarters away,
Buffett and others have begun buying now.
For starters, Buffett likely tooknote of the fact that
tangiblebook value stands at $29 a share. Even after an impressive
recent spurt, shares trade just above book value. Also, Archer
Daniels is copying the moves made so successfully by rival Bunge
--opening a series of grain- and soybean-processing facilities
around South America tocapitalize on a region that is less likely
to experience drought.
In addition, Archer Daniels is slowly de-emphasizing
ethanol production, which had consumed a huge amount of capital
with only modest returns. The company is the industry's biggest
ethanol producer, and if rivals also curtail production, then
ethanol pricingwill likely firm up. If the U.S. government moves
ahead with plans to adopt "E15" (gasoline that uses 15% ethanol),
then demand and pricing should also boost Archer Daniels'
results. (Gasoline prices have also been rising this winter, which
makes ethanol comparatively more attractive, even if E15 doesn't
come to pass and just remains E10.)
As it stands, the nationalquota for ethanol will rise 4.5% this
year to 13.8 billion gallons, though that remains below the
industry's structural capacity of 14.7 billion gallons.
Of course, the near- and mid-term future for Archer
Daniels will hinge on U.S. growing conditions during coming
quarters. The company is very volume-sensitive, so if our nation's
corn output rebounds, then Archer Daniels' processing
facilities will be closer to full utilization. And a firm corn crop
reopens the door to U.S. exports. "ADM has greater exposure to U.S.
corn exports than Bunge, and would likely be the biggerbeneficiary
of the increase in U.S. corn exports we expect starting in
February," notedanalysts at Morgan Stanley.
To be sure, Buffett never takes a big position in a big company
on a whim that climate conditions will produce favorable results in
coming quarters. Instead, he likes businesses that have wide moats
and generate considerablefree cash flow . Archer
Daniels sure has a wide moat, but thecash flow generation has
been erratic. The company alternates years of positive free cash
flow with negative ones. On a cumulativebasis , it has generated a
$5.6 billion free cash flow loss during the past six years.
Yet in the past few quarters, management has begun speaking of a
much greater emphasis on capital allocation, returns oninvestment ,
and importantly, free cash flow. Indeed, during the past three
years, Archer Daniels has invested roughly $6 billion
incapital expenditures (capex ) to boost the profitability of its
divisions. Those gains aren't yet in evidence, due in large part to
the drought of 2012, but shouldbear fruit as crop conditions return
to normal. That's surely what Buffett is anticipating.
The stars were last aligned for this company in fiscal (June)
2009, when Archer Daniels generated $3.1 billion in
positive free cash flow. Compared to the current $21 billionmarket
value , this ratio apparently impresses Buffett.
The key question: Will Archer Daniels return to that
financial strength soon? Analysts at BMO Securities believe so.
"ADM'searnings power likely has increased with recent capex
projects that have expanded the company's capacity and reduced its
cost structure." Although per-share profits have been stuck around
$2.50 in fiscal (June) 2012 and likely again in fiscal 2013,
earnings per share should approach $3 in fiscal 2014, according to
Risks to Consider:
Precipitation remains below average across much of the United
States this winter, so a drought in 2013 as well can't be ruled
Action to Take -->
Archer Daniels' turnaround story has kind of slipped
under the radar. The company hasn't made bold headlines with its $6
billion business revamp, preferring to let actions (and cash flow)
speak for themselves. Although shares have moved up off of their
lows, they remain well below the mid-$40s range seen in the past
major agricultural cycle.