The Department of Energy (DOE) was generous to the large as well as small fry in its December 2009 biofuel grant awards. Archer Daniels Midland (ADM) was awarded $24.8 million to match its own investment of $10.9 million in a project to produce ethanol and ethyl acrylate using acids to breakdown biomass as part of a pretreatment step. The compound ethyl acrylate is used in the production of plastics, adhesives and coatings among other materials. In addition to this chemical and ethanol fuel, the project is expected to produce non-polluting by-products that can be returned to the soil.
ADM is not a newcomer to the sustainable energy production scene. Indeed, public filings and public relations releases tout the company’s leadership in renewable fuels. For example, ADM’s press release announcing the DOE grant award devoted two paragraphs to outline ADM’s cooperative efforts with agriculture equipment producer Deere & Company (DE) and Monsanto Company (MON) to develop “sustainable biomass collection and transportation” capabilities.
ADM reported $1.6 billion in cash on its balance sheet at the end of December 2009. Its shares trade at 15.8 times trailing earnings and 9.3 times the consensus EPS estimate for fiscal year 2010. This compares to 25 times in the agriculture industry. We estimate the company’s cost of capital is near 9.0% versus 8.3% return on its equity.
This project will be among the most interesting to watch over the next couple of years. Not only is the science behind the acid-based process under scrutiny, taxpayers and investors alike should be asking why ADM needed the U.S. government to fund two-thirds of the project. With a respectable valuation in the public equity market ADM should be eager to finance any viable biofuel project on its own thereby retaining complete control over timing and process.
With such significant capital resources, why is ADM management unwilling to take the risks associated with a project that requires less than 2% of the company’s cash resources to complete? If ADM’s research scientists and product development engineers could not figure out this acid-based process, who can? Perhaps the project is too risky for U.S. investors as well.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.