Thursday, October 16, 2008

Archer-Daniels-Midland (NYSE:ADM): Actionable Call Alert

- Merrill Lynch is upgrading Archer-Daniels-Midland (NYSE:ADM) to Buy from Neutral noting the recent ~40% correction in commodity prices has lowered ADM’s working capital needs and improved the company’s cash flow significantly. This improvement in cash flow has also allowed ADM to repay all the commercial paper ($2.2 billion) it had outstanding at fiscal year end (June). Firm expects commodity prices to continue to moderate, which should strengthen ADM’s balance sheet further.

Raising F2009 EPS estimate on LIFO gains: As crop prices rallied over the past few years, ADM’s earnings have been negatively impacted with nearly $800 million ($0.83 per share) in LIFO charges. With crop prices retreating, they are now estimating a sizable LIFO gain in F2009— $0.32 per share vs. previous $0.05 per share estimate.

Share repurchase possible given cash position: Given that ADM had roughly $2.8 billion in cash and cash equivalents on its balance sheet at F2008 year end (or approximately 25% of its current market cap), and considering the sell off in the stock over the last few months, the firm thinks the company will come under increasing pressure to repurchase shares. They would expect some movement on this front once the company has wrapped up its annual meetings with the rating agencies—scheduled to take place this month.

Notablecalls: I like this call.

- The shares have traded down ~60% over the last 6 months on a combination of factors, including: grain spikes early in the summer following widespread flooding in the Corn Belt; concerns about sustainability of earnings in the near term; concerns regarding demand destruction from higher crop prices, and more recently, concerns regarding the company’s balance sheet and its financial flexibility (MLCO comment)

The end-demand is still there, especially with prices now down. ADM stock has gotten hit along with the AG space but it's quite clear they stand to benefit from lower prices as the are merely processors.

- It's cheap, trading just 6.5x FY09 EPS estimate. Especially with MLCO upping their ests due to LIFO. Free Cash Flow yield stands at a whopping 30%+. Roughly 25% of their mkt cap is cash, so there are NO liquidity issues.

- ADM has managed to repay all the commercial paper ($2.2 billion).

- Catalysts ahead. Not huge ones but it would be nice to see ADM buying back stock here.

ADM's just so much better than the Ferts.

I suspect the stock will trade toward the $18 level today.

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