Summary
- Both companies are benefitting from the rise of renewable diesel.
- Cash flows are robust and the balance sheets are in great shape.
- Both are cheap stocks that are not reflecting the positive backdrop and the improved business mixes.
The Thesis
Both Archer-Daniels-Midland ( ADM ) and Bunge ( BG ) reported earnings this week. The companies respectively are the A and B in the ABCD of the ag world's commodity trading and processing giants.
I have mentioned both companies before, but this write up is my first on both. Writing about them together makes sense because they are both benefitting from similar trends from slightly different angles and both companies have simplified and transformed themselves over the past few years.
Both companies are major processors of agricultural commodities, mainly grains. ADM has goods slide of its business from its second quarter presentation .
and
Bunge has similar capabilities although it is more focused on grain processing which is the business I want to focus on for both companies. As I have written about with Darling Ingredients ( DAR ), renewable diesel refining capacity has grown steeply in this country over the past few years from 600 million barrels in 2020 to 2 billion this year. That capacity is expected to grow at least through 2024 .
Renewable Diesel Capacity By Year ((EIA))
Unlike Diamond Green Diesel, DAR's JV with Valero ( VLO ), most of these renewable refineries use vegetable oils (mainly soybean oil) as the primary feedstock. In my opinion, this demand is a main cause behind the spiking price of soybean oil recently. As you can see below, the price of soybean oil correlates nicely with the increase in renewable diesel capacity.
Increased demand of soybean oil is also reflective of demand for soybean crush capabilities and leading to a major spike in soybean crush margins. These soybean crush margins are a tailwind for both BG and ADM.
Indeed, both companies have seen strong earnings the past two years, in both cases significantly better than expectations. This past Tuesday (10/25), ADM reported Q3 EPS of $1.86 versus $1.44 consensus estimates and BG reported $3.45 versus $2.47 estimates. ADM and BG should now deliver $7.50 and $13.50 of EPS respectively this year. Unless there is a major drop off in soybean crush margins (which I don't see unless there is some collapse in renewable diesel operations) I don't see a major contraction in earnings next year for either company.
Valuation
Historically, the main knock against both companies is that their trading operations make them "black boxes" that are difficult to gauge both risk and earnings generation ability. This knock and the traditional cyclicality of the businesses as well as higher leverage in the case of BG has held back the valuations in my opinion. While the trading operations will never go away, I believe that the rise in importance of the crushing business (and the carbohydrates biz at ADM) makes the trading operations less important, the overall businesses less cyclical and therefore should translate to higher multiples.
While I normally like to use EV/EBITDA and FCF yield as my go to valuation metrics, the street tends use earnings. While there are some weird variations over a 10-year period given headline EPS numbers (particularly at BG), one can see below that both companies are trading at historically low P/E's.
Clearly, the markets don't want to pay much for these earnings upticks. While it's possible that there could be massive additions of crush capacity or declines in renewable diesel demand, as I mentioned above, I don't think this trend is going away anytime soon. Combine that fact that both companies have taken down leverage and sport investment grade ratings and I don't understand why both stocks are trading at historically low multiples and considerably off their recent highs.
With BG at ~7x EPS and ADM ~12.50x, I think both companies are undervalued. If push comes to shove, I like BG more than ADM as I see 30-50% appreciation at BG versus 20-30% at ADM, but both companies have wind at their back.
Risks
These companies do have trading operations and therefore they could screw up hedges. I think that's unlikely as both are pretty sophisticated, anything can happen. There also could be a major shift away from renewable diesel adds. The way the world is moving I think there's more likely an increase, but again anything can happen. Lastly, there's the possibility of some devastation to soybean and other grain crops that would just mean lower volumes to process. Increases in crush capacity are a small risk in my mind given the difficulty of securing well located real estate for those plants.
Conclusion
Given the operational and balance sheet strength of both companies, their newly found focus, the increase in the industrial components of their business, prodigious cash flows, secular (or super-cylical at worst) tailwinds, and cheap multiples, I think both of these stocks have very good risk reward metrics. Both play well in an inflationary environment and should do well in times of geopolitical tensions.
For further details see:
Bunge And Archer-Daniels-Midland: Play The Trends