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Bearish on Archer Daniels Midland

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We are downgrading our long-term recommendation on Archer Daniels Midland Company (ADM - Free Report) to 'Underperform' from 'Neutral', based on disappointing fourth quarter 2012 results.

This leading food processing company's quarterly earnings fell approximately 45% year over year to $0.38 per share, missing the Zacks Consensus Estimate of $0.62.

Operating profit for the Agricultural Services segment declined due to tight U.S. crop supplies impacting both export volumes and U.S. merchandising results, while operating profit for the Corn Processing and Oilseeds Processing segments were affected by negative ethanol margins for the former and weak results in cocoa and other for the latter.

By nature, the agricultural commodity-based business of Archer Daniels is capital intensive, and hence requires sufficient liquidity and financial flexibility to fund operating and capital requirements. Thus, limited sources of cash generation and any difficulty in accessing external financing may significantly weigh on the company’s results. As of year-end 2012, Archer Daniels had about $1,291 million in cash and cash equivalents, while long term debt was $8,212 million.  

Despite the adverse effects of poor earnings results and increased debt burden, Archer Daniels continues to move ahead with its rapid expansion strategy, which includes expanding crushing capacities in North America, and fertilizer blending and biodiesel capacities in South America. In Europe, the company has acquired processing facilities in Czech Republic and Germany and three storing facilities in Slovakia.

In addition, in order to tap the growing global demand for crops and agricultural products, Archer Daniels is expanding its global footprint in the emerging markets, especially in Asia. These initiatives offer a strong upside potential to the company in the long run.

Although Archer Daniels’ expansion strategy of increasing its global footprint in the key agricultural regions via acquisitions and joint ventures is a positive trait, we believe sourcing of commodities and stringent credit facilities may pose a threat to its operating performance.

The company faces  intense competition and adverse currency fluctuations. This may undermine the company’s long-term initiatives and dampen its financial results. The company’s prime competitors include Cargill Inc., Bunge Ltd. (BG - Free Report) , Tyson Foods Inc. (TSN - Free Report) and Corn Products International Inc.

In the event of such poor earnings and financial prospects for the near term, Archer Daniels maintains a Zacks #5 Rank, implying a short-term ‘Strong Sell’ rating.

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