Buenos Aires, June 24th. Today, we share this valuable comment from Stephen Simpson, financial analyst, published by SeekingAlpha.com, about Adecoagro, one of the largest South America farming company, with a large sugarcane operation in Brazil and cash crops in Argentina. Mr. Simpson asks himself “how long investors can be expected to wait for that value to show up in the share price”.
Adecoagro (AGRO) has been a frustrating name for quite some time, and one where nobody has really made any money on a long-term basis for the better part of three years. All of that comes despite a very efficient sugar/ethanol business, a low-cost farming operation, and a land bank that has consistently yielded healthy premiums to the appraised values. Weak sugar prices and volatile crop prices continue to do their damage, though, and it will take a little while longer before investments made into the rice and dairy businesses provide any real benefits.
This year (2019) will likely be the peak capex year for the company’s five-year capex plan, a plan that management believes will lead to EBITDA of around $400 million and FCF of $200M on a run-rate basis by the end of 2021. The Street continues to price in far, far less than that, though. I continue to believe that Adecoagro is undervalued on a long-term basis, but at some point it is fair to ask just how long investors can be expected to wait for that value to show up in the share price.
No Real Relief In Sight For Sugar, And Ethanol Can Only Help So Much
I’ve been writing for a while now about the weak environment for sugar prices for producers like Adecoagro and Cosan (CZZ) and that continues to be the case. Apart from a brief window of time in the fall of 2018, sugar prices have stayed below $0.14/lb since March of 2018 and below $0.16/lb since March of 2017. As one of the lowest-cost sugar producers in the world (along with Sao Martinho), Adecoagro can still make money at these levels, but not nearly as much and not as much as they can by diverting their sugarcane toward ethanol production.
Although producers in Thailand, India, and Europe can’t afford to keep adding acreage at these prices, it will likely take at least two years (barring unpredictable factors like weather) for sugar prices to recover to more reasonable levels.
In the absence of attractive opportunities for sugar production, Adecoagro has leveraged its well above-average production flexibility to shift its production toward ethanol. While most other producers can only shift their production toward around 60% ethanol on a sustained basis, Adecoagro has shifted from the 70%’s a year ago to 80% in the fourth quarter of 2018 and 97% in the first quarter of 2019. That skew toward ethanol isn’t sustainable, and was driven in part by weather-related issues that led the company to postpone some crushing activities, but the fact still remains that the company has an uncommonly high level of production flexibility.
During the first quarter, ethanol prices were more than 20% higher than comparable sugar prices, and while the hydrous ethanol price has shrunk some since then, anhydrous ethanol prices are still attractive. Moreover, with higher oil and gas prices, ethanol will be even more attractive in Adecoagro’s core Brazilian ethanol market.
Farming Is Still A Tough Business
Similar to the sugar/ethanol business, Adecoagro’s farming operations are quite efficient and productive on comparable bases, but the profitability of the business has been affected by weather and global commodity price moves.
Farming revenue rose 25% in the first quarter, but crop revenue was up only 1% as an 18% increase in volume (driven by strong yields) was counterbalanced by a double-digit decline in realized prices. Moreover, it’s still tough to get a good grasp on where prices are heading; African Swine Fever is likely to reduce Chinese demand for soy and corn (for hog feed), but the U.S.-China tariff battle is leading China to turn more toward Brazil and Argentina, and heavy rains in the U.S. could provide some further price support for 2019.
Rice and dairy are doing better for Adecoagro, and these are also consistently more profitable businesses for the company. It’s no real surprise, then, that these are areas where the company is looking to make significant capacity-expanding capex investments. It will take a few years for those investments to pay off, but they should help improve EBITDA margins and free cash flow in 2021 and thereafter.
I would also note that the company continues to find opportunities to maximize the value of its land bank. The company sold a small farm in the first quarter (Alto Alegre) for $16 million, or a 33% premium to its appraised value.
Given the significant impact of commodity prices (oil/gasoline, row crops, etc.) and weather on Adecoagro’s financial results, modeling sometimes feels like a fool’s errand. Nevertheless, I believe the company’s investments in sugarcane, crushing/milling/distilling, dairy, and rice capacity should help support long-term revenue growth on the high end of the mid-single-digits. I expect that long-term EBITDA margins will likely stay in the low-to-mid 30%’s, but I do expect FCF to improve as the company moves past this period of more intensive growth-oriented capex.
The Bottom Line
I still believe $9 to $10 is a reasonable range for the shares, but the shares have noticeably lagged Cosan and Sao Martinho over the past year, and I think there’s a lot of frustration out there towards this company and the share price performance. The capex decisions that management are making make sense to me and should support better results in the future, and there’s certainly upside if/when those management targets for EBTIDA/FCF start looking imminent, but investors considering these shares need to at least consider the “value trap” risk.