As one of the world's largest providers of food ingredients,
including corn, wheat, and soybeans, the most prominent story and concern
revolving around Archer-Daniels-Midland (ADM 41.80, -2.69, -6.05%) has been China's tariff on U.S.
soybeans. It was reported late in 2018 that U.S. soybean exports to China had
all but evaporated, down about 94% from 2017. What's remarkable, though, is
that ADM has largely been able to work around this major hurdle as it has
shifted volume to other markets, most notably including Brazil and South
On that note, drought conditions in South America wiped out significant portions of soybean plants there in Q2 and into Q3, forcing customers -- including Chinese customers -- to purchase U.S. soybeans. Argentina, which is actually the world's largest supplier of soybean meal, was hit especially hard as its 2018 soybean harvest was near record low levels.
Consequently, ADM was able to help fill the supply gap, boosting its top-line growth rates in Q2 and Q3 to levels not seen in more than five years.
Of course, as the drought loosens its grip, South American soybean harvests will likely normalize in 2019, wiping out a significant catalyst for ADM that allowed it to offset the lack of exports into China. That said, there has been some positive movement recently in terms of trade negotiations. Specifically, on February 2, it was announced that China state-owned firms bought at least one million tons of American soybeans. Although that is just a drop in the bucket, it was an encouraging development that provided some hope that a more substantive deal on trade could be reached in the near future. For its part, ADM commented during its earnings call this morning that it indeed does expect the trade dispute to be resolved this year.
While the effects from the China tariffs have largely been mitigated thus far, ADM had no answer for the margin pressures it experienced in its Carbohydrate Solutions segment (40% of annual revenue), particularly in the EMEA geography.
For 4Q18, ADM posted EPS of $0.88, missing analysts' expectations by $0.04. That was the company's first bottom line miss since 3Q17. After those two outlier quarters of strong revenue growth, ADM's sales dropped by 0.8% this quarter to $15.98 bln, coming up well short of the $16.8 billion consensus.
The primary culprit came from the Carbohydrate Solutions (corn processing, corn & wheat products) segment, which saw a 10% drop in revenue while operating margin plummeted to 22.9% from 38.8% in the year ago period. While starch and sweetener volumes remained firm in North America compared to the year ago period, ADM's overall results were hit by lower sales and margins in the EMEA region. Higher liquid sweetener costs escalated its cost of goods sold and lower production rates at its Decatur, IL plant also hindered its results. On top of that, inventories and industry run rates remain elevated, putting downward pressure on prices. Unfortunately, ADM is expecting these headwinds to persist into Q1 as it expects results from its Carbohydrate Solutions business to be somewhat lower compared to 1Q18.
On the positive side, its Oilseeds segment was a clear outperformer with revenue up 13% and operating profits more than doubling year/year to $432 mln. In the oilseeds business, which is involved in originating, transporting, merchandising, crushing, and processing soybeans, crushed volumes actually came in near the highest levels in its history. And, again, South American origination results were strong, helping to offset the lack of exports to China. During the earnings call this morning, ADM estimated that about 70% of the export volume that was originally expected to go to China was filled by sending it to Europe and other Asian markets.
On the heels of these very strong results in its Oilseeds segment, ADM is anticipating less spectacular growth here as it begins to lap difficult year/year comparables. However, it still believes 2019 will be a solid year in the oilseeds business, expecting crushed margins to be well above what it has seen over the past five years. Additionally, the company's recently formed joint venture with Cargill to provide soybean mean and oil in Egypt should provide a lift this year.
Growth Projects & Cost Savings
There are a lot of moving parts and variables involved with ADM's business that are out of its control: commodity production and prices, weather issues, tariffs and trade conditions, transportation costs, to name a few. But, as far as what it can control, ADM has been proactive in terms of expanding its business - both geographically and its products lines - while identifying various earnings levers.
For instance, since 2014, ADM has invested more than $5 bln in growth projects, including 17 acquisitions and six plants. ADM is expecting the full impact of these investments to flat out this year and next. Simultaneously, it has been conducting systematic reviews of the processes around the company, such as in procurement, data infrastructure, and maintenance, looking for areas to simplify in order to become more efficient and nimble.
So far, ADM has delivered $300 mln in annual run rate benefits from these initiatives, and by the end of 2019, it expects its cost savings efforts to provide another $200-$250 mln boost to its bottom line.
Key Takeaways: ADM missed analysts' expectations by a fairly wide margin, but, investors can't point their fingers at China -- at least, not yet. The company has mostly been able to mitigate the loss of exports to China by becoming a major soybean supplier in South America and Europe. However, the drought conditions that ravaged Argentina, Uruguay, and Brazil more or less forced customers (including China) to go through ADM for soybeans. As weather conditions normalize in South America, ADM may find it more difficult to fill the void left from China's soybean tariffs. At the same time, ADM is facing some significant margin pressures in the EMEA region for its corn-based products as higher input costs, elevated inventories in Europe, and lower production at one of its main U.S plants drive results lower. To conclude, ADM was able to mask these headwinds with the strong demand emanating from South America. Now, with that demand softening, it is facing a more challenging environment this quarter. That said, if a trade resolution with China is reached, business conditions can brighten in a hurry for ADM.
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