By: Michael Vodicka
“Looking forward, it is clear that the world is struggling with a serious food problem. In fact, the United Nation estimates that global food production needs to increase by more than 70% over the next 20 years just to keep up.”
“The State of Food Insecurity in the World 2011.”
Sounds pretty scary, doesn’t it? But that was the name of the United Nation’s Food and Agriculture Organization’s (FAO) annual report last year, showcasing the alarming trend of food scarcity that continues to grip the world.
And as we grind through 2012, that momentum is showing few if any signs of slowing. In early April, the FAO’s food price index came in at 216, just a dash short of the all-time high of 235 from April of 2011 as a growing global population competes for limited resources.
And just yesterday, a mid-week update from Bloomberg highlighting how emerging markets are affecting food prices, exports and grain inventories.
“U.S. exporters sold 682,500 metric tons of corn, including 262,500 tons to China and 420,000 tons for unknown destinations, the Department of Agriculture said yesterday. The sale was the third in as many days, bringing total purchases this week to 1.28 million tons. U.S. exporters sold 826,213 tons of corn the week ended April 19, nearly triple the amount sold a week earlier, the USDA said today.”
Did you catch that? It said corn exports had tripled from last year. How many businesses or industries do you know that can boast such a claim? That’s no incremental gain. That’s a virtual tsunami of demand and consumption pouring out of one of the emerging market’s biggest players in China.
It’s all over the charts too, where grain prices continue to outpace both inflation and equities.
Grain ETF (JJG) vs S&P500
Looking forward, it is clear that the world is struggling with a serious food problem. In fact, the United Nation estimates that global food production needs to increase by more than 70% over the next 20 years just to keep up. So even though there are certain humanitarian considerations in play here, it also represents a secular investment opportunity for those operating ahead of the curve.
How do I Play the Trend?
So now that we’ve identified the trend, here’s how to play it.
Bunge, Inc. (BG) is an established name in the agriculture space, with a history dating back almost 200 year. As a large mid-cap of $9.6 billion,the company is big enough to out scale Johnny-Come-Lately while still small relative to industry giant Archer Daniels Midland (ADM) and even Conagra Foods (CAG). That provides a very nice combination of growth and stability.
Like its larger peers, Bunge is an integrated agriculture company, operating five distinct business units across key markets. Its Agribusiness segment is by far its largest, accounting for roughly 69% of revenue in its most recent quarter. It’s four other divisions are Sugar and Bio Energy, Edible Oil Products, Milling Products and Fertilizer.
Although the company’s Q1 results fell short of expectations, a closer look reveals more than a few reasons to be bullish.
Agribusiness is Hot
The first is the company’s previously mentioned Agribusiness, where Bungee is a major wholesaler and distributor in key grain markets like corn, beans and wheat. In terms of agricultural production, this is about as far up the supply chain as a public investor can go in agriculture stocks. That means both pricing and margin power, enabling Bunge to capitalize on rising commodity prices due to inflation and growing demand from emerging markets.
That dynamic was on display for the first three months of the year, where Agribusiness was a shining star after sales jumped 15% from last year. Bunge’s strategy to tap into lucrative international markets looks well on track, with results out of South America, Brazil and Canada providing tail winds. The company also added new grain processing facilities in the US and two new oilseed processing facilities in Asia that will drive production capacities. That helped Bungee boost production sharply, jumping to 30 million tons from 24 million last year.
Financial Profile
Bunge will also continue to benefit from its strong financial profile,where cash and equivalents jumped more than 50% from last year to $1.25 billion. Total debt stands just over $4 billion, but keep in mind, Bunge operates in a capital intensive industry. That may look a little heavy on the balance sheet at times, but it also provides insulation from upstart competition that is frequently the bain of technology and biotech firms. That extra cash on the balance sheet will enable Bunge to expand its business and invest in new growth while its debt has it leveraged up against rising commodity prices. The company’s Debt-to-Equity ratio of 29% is below the industry average of 31%.
Estimates
As a leading name in food and agriculture, Bunge has solid analyst coverage with a total of 10 covering analysts. We saw some fairly bullish movement in estimates going into the good quarter, with the current-year estimate adding 9 cents over the last three months to $6.76. The next-year estimates gained 30 cents in the same period, climbing to $7.35, a solid 9% growth projection.
Analysts are bullish in the long-term too, projecting 11% annual earnings growth over the next five years. Take a look at movement in estimates below ahead of Bunge’s Q1 results. We haven’t seen any new movement in estimates off the good quarter but with management looking for margin expansion in the back half of the year, earnings should follow.
Bunge Estimate Trends
Valuation
Those solid gains on the income statement have helped keep the valuation picture in check, where BG trades at historically low levels. It’s current forward P/E of 10X is safely below its 10-yr median of 12.7X. The high from this period is 23X while the low is 4X, so BG trades at the lower end of its long-term range.
The company’s price/book multiple of .84X is well below the industry average of 2.65X. It’s price/sales multiple of .16X also looks cheap compared to the its peers .94X. As a fairly mature company, Bunge won’t grow like some of its small and mid cap competitors, but the valuation has clearly diverted from its historical trend.
Take a look at the table below to see how BG’s forward P/E has compared to its peers over the last ten years.
10-Year Valuation Table
Triggers
The biggest catalyst for the strength of Bunge’s earnings profile would be higher grain prices. In 2008, when shares of BG ripped higher above $160, it came on the heels of sharp price increases in key grain market like corn, beans and wheat as a nasty bout of inflation hit the Street.
The Fed is an important part of this conversation. The central banks of the world have flooded the global market with liquidity over the last 4 years to fill the deflationary black hole left my by financial implosion of 2008. With Europe once again looking weak, the onus is on the Fed to keep stimulating. That of course is inflationary, with stands to put a long-term bid into the grain suite.
But the biggest factor effecting grain prices is demand from emerging markets. With countries like China, Brazil and India scooping up record amounts of food resources,sustained emerging market demand will continue to be a very key factor in Bunge’s success.
Risks
But a conversation about Bunge wouldn’t be complete without discussion of its smaller units, where the company has struggled to turn the corner and execute a profitable strategy. Outside of Agribusiness, the company’s four other units combined for a net loss of $59 million in Q1. Particularly hard hit was Fertilizer, chiming in with a $74 million loss while other fertilizer companies like CF Industry Holdings (CF) burn up the charts to a new all-time high. Bunge needs to execute an effective strategy in its other divisions outside of Agribusiness in order to unlock its true value.
Additional risks pertain to some of the previously mentioned issues, like weakness in emerging market and deflationary pressures out of both Europe and China.
Margins will also be in play, where higher fuel and distribution costs threaten the bottom line.
5-Year Chart
Take a look at how Bunge has performed relative to its peers and the market over the last five years. Shares have underperformed while earnings have grown, leading to the stock’s suppressed valuation.
The Big Picture
Bunge probably isn’t a stock that is going to rip higher and burn up the charts. But that’s OK, because that’s not the reason you own a stock like this. But what Bunge does have is a leading presence in an industry with very high barriers to entrance that is benefiting from a secular trend. And with the valuation temporarily suppressed due to weakness in some of its smaller units, this is a chance to buy a solid Ag stock that has fallen slightly out of favor with the Street.
Author
Michael Vodicka is the president and founder of the Vodicka Group, Inc., a Registered Investment Advisor (RIA). He specialized in trading fixed-income derivatives at the Chicago Board of Trade before spending five years managing equity portfolios for a private investment research company.
Michael graduated from the University of Kansas with a degree in business communications and is registered with the State of Illinois and the SEC (Securities and Exchange Commission) as a Licensed Investment Advisor (Series 65).
