This undervalued food company is a standout

Extremely few consumer names remain a buy, but there are good reasons to consider Bunge.

By Minyanville.com Aug 30, 2013 4:25PM
Image: Corn field (© Sean Way/Design Pics/Corbis)I recommended purchase of the international agribusiness and food company Bunge (BG) at $58 in January of 2012 (see Why Bunge Is a Buy Now).  It still is a buy.

Second quarter EPS came in at $.74 vs. the Street's estimate of $1.29, as both sales, and particularly margins, came in below expectations.  That can reasonably be explained by low crop volumes processed in North America, resulting in low margins in processing.

I would expect that to be the story for the third quarter result as well, because of little North American volume and because, though management sees a stronger second half result when a normal-sized North American crop comes in, the bulk of the harvest could possibly be late. That crop should put investor emphasis on the 2014 earnings for a normal year of higher operating rates and lower crop prices leading to high margins as well.

In Brazil, results came in better than originally expected. Logistical problems with high crop volumes were expected to hurt margins more than was the case, so some analysts think that profitability could be higher in the future. Sugar and bio-energy volume was also above expectations.  Here, continued volume strength and pricing two to three cents above the present $0.16 per pound will be important to achieving profitability.

With volumes up in the fourth quarter, Bunge may achieve a return equal to its cost of capital, the first time that will have happened in at least a few years.

But the best thing that came out of the quarterly EPS meeting was that management said they were going to reduce capital expenditures by $200 million in 2013, to $1 billion --  as they believe, and rightfully so, that there has been excess capacity in soybean processing and its other businesses for some time.  Management also said that it would be scrutinizing capital expenditure requests more toughly in the future.  It was good to hear management comment that share repurchases and acquisitions have both become priorities.

The stock is undervalued; one of the extremely few consumer stocks that is. At $75 per share and using the sell side consensus next-12-months EPS for the next two years of $7.20 and $8.38, respectively, the stock discounts a 0.5% growth rate to infinity. (That is using a 4.2% risk-free rate, consisting of a 3.7% long T-bond and an additional 0.5% because of the Fed’s quantitative easing.) Putting together the now normalized $8.38 with the conservative 5% five-year growth rate from my original buy recommendation, the stock should be $89, 18% higher.

Beyond that is the issue of the approximate 7% risk discount applied to BG, which I said is too high in my original article. If BG, Archer-Daniels-Midland (ADM) and others lower their capital expenditures and get returns somewhat higher than their cost of capital, and possibly buy back some shares, I believe that the risk discount could reasonably fall into the 6.5% area over the next two to three years.  A 6.5% risk discount points to a $94 price.

News of cuts in capital expenditures are normally positive catalysts for a stock, especially one selling at 1.2 times tangible book value.  I am moderately surprised that the stock is not higher now. 

I believe that one reason may be investor fears of an early frost because this year’s planting was completed late in the season; it was the latest planting completion since 1984.  My understanding is that there is no specific close relationship, and that temperature and sunlight in the growing season can be more important.

 I believe that the stock price could start to rally within the next six to seven weeks as the fear of early frost diminishes. Another factor may be just skepticism that capital expenditure will truly be cut, longer term.

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