ADM, Bunge More Undervalued Than ConAgra
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Food & agricultural businesses all too often suffer from not only intense competition but a notorious reliance on subsidies. With that said, there are some attractive buying opportunities in the sector, such as Archer Daniels Midland Company (NYSE: ADM) and Bunge Limited (NYSE: BG). Others, like ConAgra Foods (NYSE: CAG), are overvalued and unlikely to outperform from here. Below, I review the fundamentals of all three producers.
ADM & Bunge
ADM trades at a respective 14.9x and 11.7x past and forward earnings versus corresponding figures of 14x and 9.2x for Bunge. Both are forecast double-digit annual EPS growth over the next five years, which exceeds the weighted average cost of capital and thus will drive value retention should multiples just hold constant. Analysts nevertheless rate ADM closer to a "sell" than a "buy;" Bunge is merely a slight "buy."
It is particularly unfortunate that the drought has led to many investors losing touch of ADM's otherwise impressive fundamentals. Weaker-than-expected performance in the first quarter was characterized by a 1% y/yy decline in the top-line and a devastating 45% decline in earnings. Margins fell from high input prices, and this was felt through nearly every segment. This trend was driven by an industry that is trying to reduce inventory under considerable volatility.
Even though Bunge is forecast slower revenue growth, it has lower risk than ADM. The dividend yield may be nearly 100 bps lower at 1.6%, but the fundamentals are considerably less volatile. Management has guided for a strong second half as the investments in sugar and fertilizers begin to pay off. Bunge has an excellent balance sheet that can properly be used to increase scale and dilute fixed costs. Total volumes have been on the rise with quarterly performance representing a 14% increase over last year. I ultimately recommend betting on both firms, since I think the poor macro climate has taken away attention from the cyclicality of these stocks. When weather improves, the story will become more optimistic and shares are likely to elevate. Even if they don't, earnings forecasts are strong enough to generate meaningful returns.
ConAgra Foods
Unlike ADM and Bunge, ConAgra is more of a food marketer with brands including David Seeds, Reddi-wip, Hebrew National, Hunt's, and Slim Jim. Its diverse portfolio makes it a prime breakup target similar to what is being done at Kraft. In particular, management will do well spinning off its private label business that looks like a particularly high-growth unit under the context of a full recovery. ConAgra has been building up its portfolio over the years through acquisitions in small and medium-sized businesses - the time is ripe to now bundle them up in a way that unlocks shareholder value.
While management has argued that the acquisition strategy, absent a breakup, has enabled distribution synergy and overhead leverage to improve, the numbers tell a different story. Despite the 22.9x PE multiple being at a nearly 80% premium to the historical 5-year average PE multiple, free cash flow trends have been weak. FCF for the TTM ending May 31, 2012 was $725 million versus $905 million in May 31, 2011. Yes, it's a turnaround from losses between May 31, 2008 and May 31, 2009, but the momentum has not been nearly strong enough to justify the current $10.4 billion market capitalization.
Assuming the company meets expectations for 6.7% annual EPS growth over the next five years (nearly double what was achieved over the past five), the price of the stock will be $40.96 at a 16x multiple. Discounting backwards by 10% yields a present value of $25.43 - more ore less in-line with the current margin of safety. Given how high multiples currently are, there is likely to be downside pressure hereafter. Accordingly, I recommend staying away from an investment in ConAgra.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Archer Daniels Midland Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
