2023-10-24 03:01:34 ET
Summary
- Bunge Limited is one of the largest global agricultural companies and is set to merge with Viterra, which could drive growth and improve profitability.
- The company's financial performance has been average over the past decade, with volatile revenue and also unstable free cash flow margin.
- Bunge's stock is currently trading at a substantial discount, but there are risks involved with the merger and the unfavorable macro environment.
Investment thesis
Bunge Limited ( BG ) is one of the largest global agricultural companies, and its announced merger with another giant, Viterra, will make the combined business an even more significant player in the industry. While I consider this big strategic deal reasonable for Bunge to drive growth and improve profitability if synergies are realized, business combinations of that scale are very risky due to potential integration struggles. The company also currently experiences substantial pressure on top-line growth. Therefore, given all the risks, I consider Bunge's stock trading at a substantial discount as fair. All in all, I assign BG a neutral "Hold" rating.
Company information
Bunge is one of the world's largest agribusinesses and food companies. Its integrated operations cover oilseed processing, production of vegetable oils and protein meals, grain processing, packaging plant-based oils, and wheat flour and sugar production.
The company's fiscal year ends on December 31. BG conducts business via four reportable segments: Agribusiness, Refined and Specialty Oils, Milling, and Sugar and Bioenergy. According to the company's latest 10-K report , Agribusiness is by far the largest BG's segment.
Financials
The company's financial performance has been average over the past decade. I do not consider Bunge's financial performance as strong over the long term because revenue has been very volatile and demonstrated almost no growth. Moreover, despite the gross and operating margin expansion, the free cash flow [FCF] margin ex-stock-based compensation [ex-SBC] deteriorated over the decade and was also volatile. But it is also important to underline that the FCF margin has been consistently positive over the decade, except for the COVID-19 year, FY2020.
Having a consistently positive FCF margin enabled the company to build a strong balance sheet with a moderate leverage level and solid liquidity metrics. Despite having razor-thin profitability metrics, the management did well in balancing between sustaining a healthy balance sheet and keeping shareholders happy with solid dividend growth over the past decade. However, the forward dividend yield of 2.6% might not look very attractive given the current environment of high interest rates for U.S. Treasuries. The good sign is that the dividend payout is relatively low at below 20%, meaning that the dividend is safe.
Seeking Alpha
The company's recent financial performance was disappointing from a revenue growth perspective. The latest quarterly earnings were released on August 2, when the company significantly missed revenue consensus estimates. Revenue declined YoY by a notable 16%. On the other hand, despite revenue softness, BG demonstrated strong YoY adjusted EPS growth from $2.97 to $3.72.
Seeking Alpha
The weakness in revenue was mostly due to the 15% YoY decrease in the major segment, Agribusiness. The segment revenue decline was due to softening volumes and lower average prices, which is a near-term bearish signal to me. On the other hand, the management's strong cost control execution allowed it to expand profitability. It is also worth mentioning that thanks to the improved working capital management, the cash flow from operations improved notably YoY, but still, it was negative in Q2 FY2023.
The upcoming quarter's earnings are scheduled for October 26. The company is expected to continue struggling with revenue growth since the consensus estimates project an 8.5% YoY decline in the top line. The adjusted EPS is expected to follow the top line and decrease YoY from $3.45 to $2.50. Another bearish sign is that there were ten EPS downward revisions over the past 90 days.
Seeking Alpha
Overall, Bunge is one of the largest global players in the agricultural industry, and its relatively recently announced merger with another giant, Viterra, looks promising. For industries with inherently thin profitability metrics, the business scale plays a critical role in increasing efficiency to expand profitability. The company's past financial performance suggests that it is difficult for Bunge to drive growth and expand profitability. Therefore, seeking synergies via merger looks like a reasonable step to consolidate and improve positions in the market. Bunge's operating margin has been much more volatile and lagged compared to its major competitor, the Archer-Daniels-Midland Company ( ADM ). That said, merging with another agricultural giant, Viterra, looks like a nice try to outperform ADM from the profitability perspective.
Even without a combination with Viterra, Bunge's massive scale gives it a wide moat. Agricultural business is capital intensive, and margins are inherently razor-thin. Thus, it would take substantial investments in low-profitability projects to match Bunge's scale, which I consider to be highly unlikely in the foreseeable future.
Valuation
The stock demonstrated a 6.3% year-to-date growth, underperforming the broader U.S. market. Seeking Alpha Quant assigns the stock a high "B+" valuation grade because current ratios are substantially lower than the sector median and mostly lower than historical averages.
Bunge has a solid dividend growth track record, and I want to proceed with the dividend discount model [DDM] approach. I use a 10% WACC as a required rate of return. Consensus dividend estimates forecast FY 2024 payout at $2.75, which I consider conservative enough given the previous dividend history. To be conservative, I round down the company's past decade's dividend CAGR to 8%.
Author's calculations
According to my DDM simulation, the stock's fair price is $137.5, which indicates a solid 35% upside potential. While the discount might look attractive to investors, let's add context and analyze potential risks in the next paragraph.
Risks to consider
While the company's planned merger with Viterra looks promising, there are a lot of risks as well. Obtaining all necessary approvals for the business combination is the first big risk since if the company fails to get the needed permissions, it might lead to investors' disappointment and the stock sell-off. Such a big deal between two leading global companies in the agricultural industry might raise monopolistic and anticompetitive behavior concerns. That said, there is no 100% guarantee that the merger will eventually occur.
If the merger happens, the combined company will face even more risks. The integration risk is the most obvious one when we speak about the merger of two large companies, each with its own strong corporate culture, approaches, and systems. There is a vast execution risk during the integration process, and the worst outcome will be not gaining the expected synergies from the combination.
Vast geopolitical uncertainty is also a substantial risk in the current environment. Two big military conflicts significantly disrupt the agricultural business and weigh on profitability as commodity prices are flying high. Escalating geopolitical tensions also increases international trade risks as well, which is a headwind for Bunge.
Bottom line
To conclude, Bunge's stock is a "Hold". Despite a solid track record of dividend growth and attractive valuation I prefer to wait on the sidelines. I am not investing because the company faces substantial headwinds due to the unfavorable macro environment and high level of uncertainty regarding the ability to efficiently merge with Viterra. The 2.6% forward dividend yield does not look attractive in the current environment of high-interest rates.
For further details see:
Bunge: Valuation Looks Attractive, But Risks Are Very High