Archer Daniels Midland Operating Profits Continue to Grow

Once again the MSM coverage skews actual results. This time they do it to Archer Daniels Midland (ADM)

The headlines "ADM Profits Falls" and "Archer Daniels fourth-quarter profit slips by more than half" are as misleading as they come. Why?

What do we really care about? The health of operations. ADM's profit of $3.30 a share last year was boosted $1.01 by asset sales. That means actual operations, what it does to make money, had a profit of $2.30 a share. This year, operations posted a profit of $2.79 a share. That is growth. Just as we tend to discount "one time" charges when they hurt earnings, we should do the same when they help and focus on core results.

Earnings call notes:

- 90% of the increase (in net sales and profits) was attributable to increases in selling prices, primarily resulting from the significant increase in underlying commodity costs. The remaining 10% of the increase in sales revenue was due to higher sales volumes.

This is important because it signals higher selling prices are sticking and not hurting demand. ADM is coming off a year of record demand and it increased, along with prices, in the current one.

Along with this was that gross profit grew approximately 12% for the quarter to $807 million as overall operating margins improved. In short, higher commodity costs are not hurting results.

- ADM expects to see higher selling prices for ethanol in this current quarter compared to last quarter. Shipments should remain at a good pace as current market prices for ethanol remain very attractive relative to unleaded gasoline.

Here is an interesting comment that came out of a question of what ADM will do in regards to debt repayment vs share buybacks:

"The agencies, of course, discourage share buy backs, but we still have some commodity volatility. We have our ongoing CapEx program that's got a little more than a year to kind of run out. We're kind of at the peak spending period as we stand here. And we see some good M&A opportunities out there that we're evaluating each and every day."

M&A is almost never mentioned on an ADM call in any way. The fact that the subject was broached in this way gives real credence to last weeks reports that ADM is planning to announce something in Brazil very soon.

On Ethanol mandate:

"We're already blending over the mandate right now. Ethanol is a lot cheaper than unleaded gasoline. So everybody is going to be trying to expand and blend as much as they can. So even if there is a waiver, which really doesn't make much sense, we still do not see the ethanol demand slowing down at all, just because it is very price competitive."

On the increased ethanol supply coming online:

Diane Geissler - Merrill Lynch: "In terms of picking up (demand) the incremental supply that's scheduled to come online over, say, the next 12 months?"

John Rice: "Yes. We keep seeing new markets come in and as ethanol is $0.60 to $1 under unleaded gasoline, more and more people keep blending it and using it."

On Ethanol Tariffs:

"There is a lot of talk about the tariffs, but logistically, Brazil is just not set up to handle and ship any more ethanol than they already are. I mean we have the infrastructure issues, we are very involved in the Brazil infrastructure. Probably over the long term, that can change, but it also comes down to just a revenue issue, doing away with the tariff, it’s just less revenue in the United States because X amount of gallons will come to the United States one way or the other." John Rice

All in all as an investor, there wasn't anything that alarmed me a a whole lot that was encouraging. Capex will peak in 2009 as new processing plants begin to come online ans that will further boost earnings. Brazil will open up and there does not seem to be anything (other than the media) stopping the blending of ethanol into gas with or without the tariff. People still need both food and fuel and until they don't ADM will be just fine.

Comments

[Sincere Man:]

I will take this opportunity to add some useful words about Brazilian bio-fuels.

As rising food prices continue to threaten food security around the world, Brazilian ethanol is one obvious solution being largely ignored. Brazil set up its efficient fuel alternative program in the 70s, when the first oil crisis hit the world. Now Brazilians drive cars moved by ethanol or gasoline mixed in any proportion. And since long ago gasoline in Brazil is not pure, but blended with 25% ethanol, resulting that internal consumption of ethanol in the country is already superior to gasoline's. Ethanol in Brazil is already much cheaper than gasoline at current international oil prices.

Brazilian ethanol is produced from sugarcane without any governmental subsidies and the fuel has a very competitive price. Researchers are increasing the productivity (more fuel extracted per sq.km. of crops) by adapting sugar canes species to each type of land and topography. The productivity now is more than 3 times the records of 30 years ago and it keeps on raising, being expected to soar very soon when the technology to extract ethanol from cellulosic materials (crop waste) will be available for large scale production.

Ethanol production in Brazil uses just one percent of total arable land, and the country can expand its sugarcane fields without disturbing sensitive land areas (like Amazon), just by tapping land such as depleted pastures. Just raising intensity of cattle production from the current 0.8 animals per hectare to 1.2 animals (a target already far exceeded in many parts of the country) would release about 80m hectares of land for crops. There remains plenty of room for expansion: the country has 355 million hectares of farmable land, of which 7 million hectares under sugarcane of which the amount used to make ethanol fills 3.4 million hectares (compared to 200m hectares of pasture). Another 105.8 million hectares remained available, which allows Brazil to increase ethanol production without affecting the environment or food. By comparison, the additional terrain for Brazilian crops could surpass all of the land now under cultivation in the European Union.

Meanwhile, Brazilian food production has doubled in the past decade and that’s the most impressive thing about ethanol from sugarcane: in contrast to corn-based American ethanol or biodiesel derived from soybean oil, there is no cost pressure and no competition with food.

Another persuasive fact for incentiving ethanol production in Brazil is the electric energy that is generated as a by-product of ethanol processing: taking into consideration the energetic balance, the electricity generated in sugar cane processing in Brazil is almost as large as its ethanol equivalence. It's like a two large scale hydroelectric plants generating electricity exactly when it's more necessary: in the Brazilian dry season! So the producers of ethanol are also having increasing revenues by selling electricity to the country's national electric system, which has become an strategic and reliable source of electricity. For all these reasons, ethanol in Brazil is a win-win game for the country, the farmers, the consumers and the environment.

Off course Brazilian ethanol does not intend to concur with petroleum, but it could ease up current oil crisis by supplying a small part of the world energy demand. It is only necessary to look at the increasing demand from the non-oil countries like India and China to understand that the very high price of oil is here to stay. With the existing price of oil, the permanent threat of war in the Middle East, the international geopolitics, and the environmental problems, there seems to be no other easy solution for the energy problem away from the liquid ethanol produced out of sugarcane. This is certainly a very important aspect of the Brazilian economy for the next few years and the rest of the world will have to accept the reality of the liquid ethanol from sugarcane as the right and best solution for the oil crisis.

The problem is that much of Brazil’s ethanol exports continues to face prohibitive tariffs and other barriers to developed markets in the US and Europe. The United States currently places a 54-cent-a-gallon tariff on ethanol imported from Brazil. Consumers in the country are being severely affected, particularly in areas such as the Southeast, where corn does not exist and the logistics to bring ethanol from the center of the country is practically impossible. It is difficult to understand the maintenance these tariff levels, except for political reasons. The developed world appears purposely myopic in relation to the opportunities Brazil presents, maybe it's because that would upset wealthy US and European farmers – a price apparently not worth paying.

2008 Aug 06 11:33 PM

[Tim Plaehn:]

From my research, Brazil is on track to export about 700 million gallons of ethanol to the U.S. in 2008. I think the comment above that the ethanol will come in spite of the tariff is probably correct, so Uncle Sam might has well collect his cut.

The comments above gives me a continued positive outlook for my investment in VeraSun Energy, earnings out next week!

2008 Aug 07 08:34 AM

[Sincere Man...:]

Although your comments on Brazil are mostly correct, the tariff on Brazilian ethanol is in place to insure that a US subsidy does not go to foreign production. As I am sure you are aware, any ethanol blended into gasoline (Brazilian included) receives a $0.51/gal tax credit by the US government. The tariff essentially nullifies the blenders credit.

The blenders credit will be reduced next year to $0.45/gal and I am definitely in favor of the tariff being reduced to that level, but as an American tax payer, I do not want my tax money going to support international production. As long as the VEETC tax credit is in place, the tariff should be as well.

2008 Aug 07 12:26 PM