The Andersons, Inc.: A Compelling Way To Play Ag

Oct. 27, 2021 2:02 PM ETThe Andersons, Inc. (ANDE)UAN5 Comments17 Likes

Summary

  • The Andersons, Inc. has posted three consecutive robust quarters, with TTM Adj. EBITDA of $340 million (through June 30, 2021).
  • On August 16, 2021, the company sold its railcar business for a 10.2X multiple and net proceeds will be used to pay down long term debt.
  • This is a high quality and under the radar physical Ag commodity trader that only trades at a pro-forma EV/ Adj. EBITDA of 5.6X. My 12-month price target is $45.
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Corn crop and Iowa farm at harvest time

Ron and Patty Thomas/E+ via Getty Images

(This article was originally written on August 11th and then updated August 17th, due to the railcar sale, for Second Wind Capital members).

My regular readers might recall that the last time I wrote about an agricultural commodity stock was back on March 14, 2021, when I called CVR Partners, LP (UAN) My Best Current Commodity Idea. As it turns out, the stock is up 167% since then and UAN also paid a distribution. That said, if we are keeping it real and intellectually honest, there was a fair bit of luck in this call, at least the second leg of the move, as the linchpin to the thesis was U.S. producers' structural advantage sourcing affordable natural gas, as this is a big input and overall cost in the production of ammonia. I covered this nuance in my original piece.

Moreover, most recently, the driver of the move in UAN's stock was its European fertilizer competitors forced to shut in production as natural gas costs exceeded $30 Mcf whereas U.S. natural gas prices are trading in the $5 MMBtu range and supply is readily available. So despite people making fanciful arguments about $7 corn being the new normal, the threat of a poor fall 2021 harvest, and low corn inventories, just to be crystal clear, the second leg up in UAN shares (as no question the stock was compelling at $30), from the low $50s to the low $80s, is mostly due to natural gas prices in Europe, notably forcing supply to be shut in.

Also, come spring time 2022, it is unknowable how inelastic demand will be for fertilizer, at least based on the recent elevated prices, as the futures curve for corn is currently stuck in the low to $5s, so I'm not sure the economics really work for farmers.

CVR Partners article

Source: Seeking Alpha

Anyway, enough about CVR Partners, LP, as today's piece is to share another Ag-related commodity stock. Similar to CVR Partners, back when I wrote about it, The Andersons, Inc. (NASDAQ:ANDE) is very much under the radar and not widely known despite a market capitalization north of $1 billion.

What They Do

The Andersons, Inc. was founded in 1947 and is a physical agricultural commodities trading firm that utilizes its logistics, storage, and merchandising assets and know how to arbitrage differences between the futures and local physical markets (referred to as 'basis'). In addition to arbitraging local basis, ANDE's experienced traders can arbitrage the market via time (referred to as the 'spread' or 'carry') depending on the structure of the futures curve and employ various other strategies to hedge and lock in fully arbitraged profits. Like all commodities markets, each agricultural commodity moves in its own cycle depending on supply and demand, existing inventories, and near term planting/ harvest expectations (think near term future supply). Some cycles are more favorable than others and the first half 2021 has been a great backdrop for trading. Tight supply and demand have led to strong prices and lots of volatility, which is great for Ag traders. Moreover, with a strong fall harvest, more physical supply is also good for The Andersons, Inc.

The company operates four segments:

  • Trade Group: (owns grain elevators and other physical assets to move agricultural commodities - mostly whole grains, grain products, feed ingredients)
  • Ethanol: (through a JV with Marathon Petroleum (ANDE owns 50.1%) owns and operates 4 ethanol plants with name plate capacity 405 million gallons as well as a 51% economic interest in a 70 million gallon per year bio-refinery in Kansas)
  • Plant Nutrient: (manufactures and distributes wholesale nutrients for fertilizers as well as engineered granules used for turf management for golf courses and lawn maintenance)
  • Rail*: (owns and leases a large fleet of various types of railcars, locomotives, and barges that are subleased to customers to move commodities)

(*The railcar business was sold on August 16, 2021 and I will discuss this later in the piece.)

Again, this company owns physical assets and isn't a derivatives shop that doesn't take physical delivery of the underlying commodities.

Enclosed below you can see The Andersons owns grain elevators and physical storage assets located in mostly the farming belt and in Canada. The company's capacity is 202,099 bushels. On the ethanol side, the company's nameplate capacity is 475 million gallons per year. This includes interests in four ethanol plants and one bio-refinery. The Andersons owns a 50.1% stake in the four ethanol plants and 51% stake in the bio-refinery.

Source: The Andersons, Inc. 10-K

The company has had a great first half 2021 and here is a snapshot of Q2 FY 2021 EBITDA per segment.

(Enclosed below, all four charts are from The Andersons, Inc.'s Q2 FY 2021 earnings call)

Trade Group

ANDE trade Q2 highlights

Ethanol

ANDE ethanol Q2 highlights

Plant Nutrient

ANDE plant nutrient Q2 highlights

Rail

ANDE rail Q2 highlights

The Setup

The Andersons, Inc.'s TTM Adj. EBITDA was north of $340 million after reporting robust Q2 FY 2021 results, after the bell, on August 3rd. Moreover, these results weren't just a flash in the pan and management was sanguine about a strong 2nd half 2021 outlook. Moreover, as this firm isn't widely covered by the sell side, but does have consistent coverage from a few sell siders, a question was asked about the repeatability of $300 million in Adj. EBITDA in 2022 (as ANDE's management set that $300 million TTM target in 2017) and here is management's response:

Source: The Andersons, Inc. Q2 FY 2021 Conference Call

So if you zoom out, during the last Ag cycle, back in 2013/ 2014, ANDE's stock briefly pierced $60 per share, but spent a fair amount in time trading in the $50s.

ANDE chart

Source: Fidelity

The 2021/ 2022 cycle is also very strong and the company is generating outsized profit. Yet, until recently, at least until mid to late October 2021, ANDE's stock has lagged its fundamentals. Perhaps, confusion is tied to its elevated short term debt levels, debt that is tethered to its readily sellable inventories. Perhaps, investors running quant screens don't get the working capital swings associated with elevated agricultural prices, in underlying commodities, given the sheer amount of volume that moves through ANDE's system. I would argue and as referenced on the Q2 FY 2021 call (see below), higher prices and attractive arbitrage opportunities are a smart use of the company's balance sheet and how they make money when the profitable trading setups exist.

Higher futures prices in the grain markets are the primary cause of our increase in working capital this year. The outstanding balance at June 30 of $757 million is supported by readily marketable inventories of $612 million and $220 million in cash margin deposits.

Per CEO, Pat Bowe, the strong trading backdrop for the second half 2021 is firmly in place and the outlook for FY 2022 is favorable.

Thanks, Brian. We continue to believe that opportunities in our agricultural portfolio will remain strong. While export demand has seasonally slowed, we expect high global demand for U.S. crops into 2022. This demand continues to support world grain trade and prices higher than historical averages. Crops in our draw areas are in great shape, while some other parts of the country are seeing dry conditions. We're optimistic about an abundant harvest that will provide us additional merchandising and elevation opportunities.

Given these conditions, we remain positive in our outlook for our Trade segment. Worldwide supplies are projected to be tight beyond this fall's harvest and U.S. growing conditions are mixed. Some minimal board carry has returned to corn and wheat, and we're able to acquire more of the dry winter wheat harvest than we earlier estimated. A large 2021 harvest will reduce but not eliminate the impact of strong worldwide demand.

We see good trading opportunities in these volatile markets and remain focused on disciplined risk management. Gasoline demand is up dramatically from the pandemic slowdown and it's expected to continue. Tight old crop corn supplies and plant maintenance shutdowns are expected to slow industry production through the third quarter. The strong demand for co-products continues to support our overall margin. We continue to produce and sell our new high-protein feed products from both our Colwich, Kansas and our Denison, Iowa plants at good margins. Our low CI efficient plants are well positioned to capitalize on higher co-product values and improved ethanol margins. We're awaiting carb approval to begin shipments from our Colwich, Kansas plant to California. We're hopeful that we'll receive it by the end of the third quarter. We expect our Plant Nutrient business to continue to perform well. Without the typical summer price reset and continued tight stocks, fall demand looks to be solid.

(Source: Q2 FY 2021 Conference Call)

What I'm Most Excited About

Outside of the strong execution and favorable 2nd half 2021 outlook, I am most excited about the possibility of this stock re-rating based on its push further into renewable diesel. This could act as a strong catalyst for the firm to show up on Wall Street's radar (think ESG) and be a future driver of EBITDA growth.

CEO, Pat Bowe, discussed this on the Q2 FY 2021 call. The Andersons is a big producer of corn oil which is used as a key input for renewable diesel. The company stood up a vegetable oil trading business last year and they want to be a big supplier. Just to be clear, and per Pat's comments, they are not going to be a crusher of bean oil, rather a key feedstock supplier.

Exhibit A

Source: The Andersons, Inc. Q2 FY 2021 Conference Call

To add some additional color on Pat's commentary about corn oil, ANDE's 10-K breaks out FY 2019 and FY 2020 corn oil shipments, which were 117.6 million pounds in FY 2020.

Moreover, on August 6, 2021, Bloomberg interviewed CEO, Pat Bowe, about the firm's renewable diesel ambitions.

Source: Seeking Alpha

And his commentary to Bloomberg is very similar to what he said on the Q2 FY 2021 conference call.

Exhibit B

A Big Strategic Shift: Selling Its Railcar Business For $550 Million, On August 16th

On August 16th, The Andersons Inc. announced a sale of its railcar leasing business for total gross deal proceeds of $550 million (before any changes in working capital) to American Industrial Transport (AITX).

Per its August 17th 11am EST conference call, the deal already closed, on August 16th. Net after tax proceeds are estimated to be $450 million to $475 million, as there will be some taxable income associated with this transaction given the accelerated depreciation schedules.

The sale price was 10.2X TTM Adjusted EBITDA, which is a healthy multiple.

Transaction enhances business portfolio

(Source: The Andersons, Inc. August 17th slide deck)

Note that the company's rail repair business, with 29 strategically located facilities, is not part of this transaction. However, that niche business is currently being marketed and should be sold within the next 12 months.

Going forward, through Q2 FY 2021, the pro-forma TTM Adj. EBITDA for this business (its remaining businesses excluding the railcar segment) is $285 million.

The Andersons at a glance

(Source: The Andersons, Inc. August 17th slide deck)

The company also did a nice job of putting this slide together to showcase the historical Adj. EBITDA power for each segment, from 2016 - TTM 2021.

Financial milestones

(Source: The Andersons, Inc. August 17th slide deck)

If we think about valuation and debt, this deal brings its total pro-forma long term debt to Adj. EBITDA to 2.2X.

Strengthens balance sheet and financial flexibility

(Source: The Andersons, Inc. August 17th slide deck)

However, please note and I mentioned this earlier, The Andersons' short term debt isn't really debt, at least not like long term debt is, rather this short term debt is tied to working capital. In other words, short term debt is offset and hedged against readily marketable inventory and cash deposits. I continue to think this is an area of confusion as so many investors resort to running quant screens, so The Andersons, Inc. appears more leveraged, at face value, than it really is. That said, the company needs access to a large credit facility in order to facilitate its expansive physical trading operations, and this requires billions of dollars of banking capital. However, again, you have to net out the readily marketable inventory and cash deposits to get to a net cash or net short term debt figure and then add long term debt.

Recall this commentary from the Q2 FY 2021 conference call:

Next, we'll move to Slide six to discuss cash, liquidity and debt. We generated strong cash flow from operations before changes in working capital of $93.1 million during the quarter, up significantly from $61.8 million in the second quarter of 2020. Our year-to-date cash flows has nearly equaled our full year 2020 levels. Higher futures prices in the grain markets are the primary cause of our increase in working capital this year. The outstanding balance at June 30 of $757 million is supported by readily marketable inventories of $612 million and $220 million in cash margin deposits.

So if we look at The Andersons' balance sheet, at the end as of June 30, 2021, I am only focused on the $866 million of long term debt. And I would argue that this is somewhat similar to when a firm like Goldman Sachs, a company that excels at risk management, and that expands its short term debt to capitalize on attracting trading setups. As The Andersons' management team cited on the Q2 FY 2021 conference call, it is a very favorable trading environment and the company is well positioned to continue its strong trading results given these continued tailwinds.

(Source: The Andersons, Inc. Q2 FY 2021 10-Q)

Pro-forma Valuation

So if we think about valuation, the company has 33.2 million shares x a recent price of $34.35 per share or a market capitalization of $1.14 billion. Let's assume net after tax proceeds (from the railcar business) yield only $450 million, and therefore long term debt gets reduced from $866 million to $416 million. So we are talking about a total enterprise value of roughly call it $1.6 billion. $1.6 billion / $285 million in pro-forma TTM Adj. EBITDA is only 5.6X.

I would argue that this is too low a valuation, especially in light of the fact that net leverage is now very marginal and manageable. So I would argue that this should lead to the stock getting re-rated higher given the reduced leverage profile.

Risks

Trading operations require excellent risk management and results fluctuate as they are based on the relatively attractiveness of the Ag cycle. These cycles are volatile and great money making opportunities might not always be present. The ethanol business is always very volatility as crush margins can vary. That said, The Andersons has a lot of scale and owns high quality and low cost facilities and its vertically integration means easily sourcing the corn. Moreover, the company has done a great job of growing its co-product revenues in the ethanol business. As for fertilizer business, this too is cyclical and can have good and bad periods and therefore EBITDA margins and volumes can vary.

Putting It All Together

From mid May 2021 to June 9, 2021, The Andersons, Inc.'s stock price was very strong and minted a then fresh 52 week high, on June 9, 2021. Subsequent to that high, ANDE's stock pulled back as much as 25%, in late July 2021, but after a few months of consolidation, ANDE shares have now recovered and sprinted to a new 52 week high, just yesterday, at $34.47, taking out its June 9, 2021 high. Given this strong technical price action, combined with upcoming Q3 earnings (released on November 2nd, and the conference call is the following morning, November 3rd) I figured would share this fairly in depth article with SA's free site readers.

(Source: Fidelity)

In terms of the fundamentals, as 90% of my process is focusing on the fundamentals, and 10% is looking at the technicals. The Andersons, Inc. is a high quality company that own strong assets that enable the company to generate outsized returns trading, storing, and then moving physical agricultural commodities throughout its network. I like the railcar divesture, given an attractive 10.2X Adj. EBITDA selling valuation, and this goes a long way to shoring up the balance sheet and improving the turns of leverage, which should, eventually, led to the equity re-rating. Moreover, as I expressed multiple times, throughout this piece, if you understand the nuances of how working capital balances can swing, with higher underlying commodities and based on the sheer number of arbitrage situations, you can't lump in short term debt when you calculate an enterprise value. Trading at a pro-forma EV/ Adj. EBITDA valuation of only 5.6X, I would argue that ANDE shares have room to run.

Lastly, I'm not sure how much attention or if Wall Street is even aware of The Andersons, Inc.'s involvement and strong initial foothold as a key feedstock player in the renewable diesel market.

My 12 month price target is $45 per share.

ANDE EBITDA milestones

(Source: The Andersons, Inc. August 17th slide deck)

Second Wind Capital is a value oriented investment service with a strong recent track record of exceptional outperformance. The focus is mostly small cap value, but opportunistic and open minded towards special situations. In 2020, the total return of the portfolio was +93%. In 2021, through September 30th, the total return of the portfolio is +89%. 

This article was written by

Idea generation, value investing, small caps and under the radar stocks.
A career wanderer and journeyman, with a passion for deep value and contrarian investing. I spent five years on the buy side in investment grade bonds on a team that managed $50 billion of assets, 3.5 years as an energy credit analyst for an energy company, and had multiple stints in corporate finance, most recently as a strategic financial analyst. I have an undergraduate degree in Finance (UMass Amherst) and earned an MBA (Babson College).


I actively invest my own capital and for a few family members.


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Disclosure: I/we have a beneficial long position in the shares of ANDE either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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