Investors in grain-processing giant Archer-Daniels-Midland (NYSE:ADM) think corn is king.
Oh, sure, ADM operates factories that crush oil out of soybeans and sunflowers, grind wheat into flour and turn cocoa beans into powder. And yes, it operates Mississippi River barges and a network of rural grain elevators, and it makes staples – yawn — from things like peanuts and the seed of the oil palm.
But corn has given ADM its most prominent profit pop in recent years, and been responsible for much earnings volatility. That’s because corn is the source of ethanol, the gasoline substitute that’s transformed large swatches of Midwest farmland into an extension of the nation’s energy sector. And ADM is one of the nation’s biggest ethanol makers.
A government effort to boost ethanol as a “renewable fuel” caused a heartland Gold Rush several years ago, spurring corn farmers to plant every acre they could. The boom pushed ADM’s long-stagnant shares to record heights. For a while.
ADM rang up big profits because it had lots of cheap corn available, and ethanol prices were sky-high. Later, after corn prices climbed and a glut of new capacity hurt ethanol prices, margins for ADM and rivals like Valero Energy (VLO) narrowed; the ethanol game grew chancier and, because ethanol prices track gasoline costs, more sensitive to the economy.
Worse, some of the generous supports Uncle Sam provides to domestic ethanol producers – a tax credit and a tariff that shields U.S. makers from import competition — are due to expire at year-end. Unless lawmakers renew them.
So, ADM shares softened lately, in part over the subsidies and in part because the company reported disappointing fiscal first-quarter earnings a month ago.
But it’s really no surprise when ADM’s earnings bounce around. Hedging can smooth things a bit. But ADM always faces unpredictable price swings buying agricultural commodities from growers, and selling processed goods to end-users.
That leaves the question of federal help expiring, reminds us of an old Midwestern joke about fedeal price-support checks.
Q: How do you double a farmer’s income?
A: Give him a second mailbox.
Ethanol makers and corn farmers may be fretting aloud, but it’s generally a safe bet the government will continue throwing money at the farm sector.
Assuming that’s so, a number of yardsticks suggest ADM’s cheap right now. Its 2.0 percent dividend yield is appealing.
As is the fact that it regularly escalates its quarterly payout.
Return on equity used to be modest, before ethanol revved up ADM’s game. Here’s ROE for Archer Daniels and for Corn Products International (CPO), which makes sweeteners and starches in competition with ADM, but isn’t involved in ethanol.
The global commodities run-up that took hold in 2007 and went bust in 2008 shows up in both companies’ ratios, but ADM held up better.
Based on its revenue uptrend, capital position and other fundamentals, YCharts Pro calls the stock undervalued. And that makes sense.
True, ADM’s exposure to fast-moving markets guarantees some quarterly surprises, welcome or otherwise. But as improving conditions allow emerging economies around the world to start eating better, global food suppliers like ADM appear positioned for long-term growth.