Food, Not Ethanol, Fuels ADM's Big Quarter

Despite all the money pouring into renewable fuels, the big story for the agricultural giant remains its grains biz

Archer-Daniels-Midland's (ADM) stock got a lot of mileage out of its big ethanol investments, but lately the fuel biz hasn't been performing up to snuff. Still, the company is profiting from its long-standing role as a worldwide agricultural middleman, processing and distributing food to an ever more populous and prosperous world.

On Nov. 6, ADM reporting earnings of 68 cents per share, vs. 61 cents a year ago. That impressed investors despite lower profit margins on ethanol production. ADM shares surged 6.5% by midafternoon on Nov. 6.

By spending big on ethanol, ADM had broadened its focus. It changed its slogan, from "supermarket to the world" to "resourceful by nature," to reflect a new emphasis on ethanol, fuel and even chemicals.

A year ago, those ethanol bets were looking very smart. Thanks to government mandates, customers couldn't get enough of the fuel made from corn. Ethanol processors rushed to build new plants, and, with corn prices high, farmers planted as much as they could.

A year later, supply is catching up to demand. While corn prices remain high, ethanol prices have fallen. ADM execs told analysts Nov. 6 that they expect ethanol prices to continue to fall.

"The dynamics of the [ethanol] industry are pretty unattractive," says Morningstar (MORN) analyst Ann Gilpin. With the cost of corn, the key raw material, high and the cost of their product, ethanol, falling, ethanol producers' profit margins are getting squeezed. Some are cancelling plans to build new ethanol plants, while others pin hopes on new government mandates.

ADM says it will keep focusing on fuels and other new products, particularly the next generation of bio-fuels. "We'll never get to some of these second and third generation opportunities if we ... abandon our corn ethanol base," ADM chairman, president and chief executive Patricia A. Woertz told analysts.

The strength of ADM's other, traditional businesses could give the firm the breathing room to stick with this strategy.

Despite the weakness of ethanol profits, the overall earnings report looked great. Revenues were $12.8 billion, up from 36% the previous quarter. Earnings of 68 cents per share beat analysts' predictions by 9 cents, according to Reuters Estimates.

The reason for the sterling results: ADM has been able to make hay from rising crop prices. "They're taking advantage of a lot of volatility in the global commodity markets," says Stephen Ham, an equity analyst at Standard & Poor's.

Growing middle classes in emerging countries like China and India are hungry for more meats and higher-end food. "Huge populations are becoming wealthier, and, as they become wealthier, their diets change," Morningstar's Gilpin says. "That's a trend that's going to persist for a while," she adds.

Also, ADM has benefited from a few short-term developments. ADM is the handler of a lot of crops from North America, which saw huge crop harvests this year. By contrast, Australia has been suffering from a drought, giving American crops less competition globally.

Still, there are concerns about ADM's long-term strategy. Gilpin worries that ADM, as a middleman in the food business, can get squeezed the same way it did on ethanol. For many products, ADM's profit margins are subject to the whims of commodity markets.

Ham, though, says so far ADM has been able to pass on food price increases on to customers as it meets growing global demand. (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

The next step for ADM? It is expected to use its substantial clout in Washington to revive its alternative fuels business. New mandates from the federal government could be what ADM needs to again rake in big profits on ethanol.

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