ADM: The Way to Play the Agriculture Commodities Game

It has been quite a while since I added any stocks to my portfolio. Yesterday, when ADM (ADM) (basically, a grain processing and transportation company) slipped under $21 / share, I could no longer resist. With most commodities having significantly retreated from their all-time peaks recently, I was once again watching agricultural commodities. Please, allow me to explain...

Three years ago, when I last looked into investing in grains, agricultural ETFs and ETNs were not yet available. ADM was trading at a reasonable valuation, but was not a screaming buy and the continual rolling over expiring commodity futures options was simply not an option for my relatively hands off style of investing. So, three years ago I decided not to invest in grains and missed out on a great moneymaking opportunity.

Fast forward to today. Despite the very best (even if misdirected) efforts from the White House, great old corporate giants are falling victim to excessive debt more and more often. This turmoil in financial markets is making everyone nervous, resulting in humongous market swings and the associated rise in the VIX volatility index.

Did yesterday mark the bottom of the markets? I certainly hope so, but I doubt it. Will it get any better soon? Probably not. But that doesn't mean that people will stop eating, does it? Food, as you may recall, is at the very bottom of Maslow's pyramid, right next to breathing. And grain-based foods that ADM handles in more than 60 countries worldwide are the cornerstone of just about every diet throughout the world. So, as long as earth's population continues to grow and people continue insisting on grown (rather than engineered) food, ADM, the largest public company involved with grain handling and processing will grow with the world.

So, why is ADM a much better buy today than it was three years ago? For one thing, it is trading at the same levels it was 3 years ago, yet by most measures, the company nearly doubled in the meantime. ADM has been paying dividends for over 75 years straight; the current yield is a respectable 2.35% and is quite easily covered by operating profit.

But why has the company lost so much value recently? I see several reasons for this, beyond the general market conditions and disappointing quarterly results. ADM is in the "food products" industry, which has been under pressure, as consumers substitute the more expensive brand names for generics. ADM does not have this problem, but its stock price experiences this industry pressure.

Also, in addition to sinking profits, reported with the latest results were increasing inventories, receivables and debt and decreasing profit margins. It appears that seeing this, investors panicked and dumped ADM shares. They did not seem to care that despite the increases, debt, receivables and inventories stayed within conservative limits. These investors also appear to have ignored the lag factor in a company's ability to pass on price increases and the fact that commodity prices have actually retreated considerably, since the end of last quarter.

If most commodities stay at current levels or perhaps even head a bit lower over the short term, ADM will surely beat analyst expectations in the current quarter! Even if commodities rebound quickly (which appears to be unlikely right now), ADM will still make the profit everyone expects it to make. In either case, the company will continue to grow. Thus, I see buying ADM as a much safer alternative to the grain ETFs and ETNs.

That's the same rationale I used in purchasing Valero (VLO) stock back in 2001 and it turned out to be one of my best investment decisions ever. I can only hope that ADM will be a repeat performance. There may be an even better opportunity to buy ADM, as the market goes through its convulsions over the next several months, but I see the under $21 / share (I bought at $20.81) as a gift already.

Disclosure: Long ADM.

Comments

[desi]

Hello Jake,

Along with the bearish outlook in the commodity sector one of the biggest concern with ADM was the "ethanol bubble". With the crude oil prices down by almost 30% from its peak of $140+ few months back it seems that all "alternative energy" stocks are getting beaten down. How does this affect ADM as it was on the ethanol binge for last few years ? Does the current pricing discounts the excesses by ADM in Ethanol production in the Mid-west ?

Thanks in advance,

Desi

[jegan ;-)]

Good point desi... This was **THE ETHANOL** play over the last couple of years.. Matter of fact, whenever Cramer was asked about ethanol, all he could say was ADM.... Doesn't mean the company is shot, just out of favor. And I expect that either candidate will maintain the ethanol program for a variety of reasons... Mainly the mid-west vote.

jegan ;-)

[Jake Berzon]

Yes, Ethanol was certainly the story on this stock two years ago. Cramer along with other TV Stock Evangelist Pundits (all big momentum players) were pumping up ADM based on this story. But ADM is so much more than ethanol. It is also biodiesel, alcohol and most importantly food.

I wouldn't fret over fuel prices dropping recently. Ethanol is a gas additive mandated by law to reduce pollution in many states. Renewable fuels are also mandated by the U.S. Energy Independence and Security Act of 2007. Retail prices of biofuels are only very loosely tied to the price of oil based fuels. They are much more a function of government imposed demand and input costs.

Today, corn is the input of choice for ethanol production and ADM has access to plenty of corn at the same prices as last year (they hedge). If corn goes out of favor, it would be relatively easy for them to convert production to other renewable inputs, like switch grass.

The bottom line is, when you can pick up such a quality stock at its tangible asset value, you do it!

[frankiecooper]

amen. ADM was a viable company way before the ethanol bubble and as long as people keep stuffing their faces and drinking soda, ADM will keep flourishing....