The Andersons, Slowing Growth Thanks to Oil and Crop Production

This was my first attempt at an investment write-up. As part of the application for our student-managed investment portfolio, applicants were tasked with analyzing The Andersons, Inc. (ANDE.) This version of my report was submitted on December 12, 2014 and ANDE's stock price closed at just above $50. Since then, my assumptions have held true, and as of March 26, 2015, ANDE's price was at $40.46. The goal of posting this version is not to boast about how "right" I was, but rather to give readers a starting point for my ideas on ANDE. After looking over this report again, I realize that my target price range may be too large. This is something I hope to improve in future reports. As always, I welcome you feedback! 

Investment Thesis

I recommend recommend target price range of $30 to $59 for The Andersons, Inc (ANDE.) Revenues in 2014 and 2015 will suffer from low commodity prices, low ethanol demand, and poor ethanol margins. As crop production slows and oil prices normalize, ANDE’s revenues will grow at a rate of 3% per year.

Drivers of Thesis

Crop Production: Record harvest levels of corn in 2013 and 2014 hurt ANDE’s bottom line.¹ As high corn production continues, revenues will remain flat. Once production of corn slows, ANDE will benefit from higher commodity prices.

Oil Prices: Increased domestic oil production will result in low oil prices in Q4 2014.² Consumers substitute gasoline for ethanol when oil prices are low, driving down ethanol prices.³ Domestic oil producers also stress the rail transportation industry, hurting profits for ANDE’s rail group.⁴ Once oil prices return to normal levels, ethanol will regain its market share and the rail group will become more profitable.

Risks to Thesis

Weather: In 2012, ANDE benefited from a drought and the resulting high grain prices.⁵ Conversely, stable growing conditions result in excess crops and decreased profits for ANDE.

Renewable Fuel Standard (RFS) Subsidy Levels: Ethanol production is an expensive business, but subsidies available through the Environmental Protection Agency’s (EPA) RFS make it a profitable endeavor. As biofuel producers race to meet RFS production goals, the EPA may reduce subsidy levels, hurting ANDE’s profits.⁶

Company Analysis and Segment Breakdown

ANDE has a five-year dividend payout ratio of 13.04% and consistent dividend growth. Their five-year return on equity is 14.58% and a five-year return on invested capital of 8.93%. ANDE’s P/E ratio over five years is 12.05, but trending upward from 8.58 in 2011 to 18.69 in 2013.⁸

ANDE divides their company into six segments: grain (65% of revenue), ethanol (15%), plant nutrient (13%), rail (3%), turf and specialty (3%), and retail (3%).⁷ The grain and ethanol groups contribute only 32% and 9% of the gross profit respectively (attributable to the high cost of goods sold for both groups). The plant nutrient group makes up 24% and rail is another 16% of total gross profit.⁸

 

In the past 12 months, ANDE purchased the assets of Cycle Group, Inc. in December 2013,⁹ Auburn Bean and Grain in October 2014,¹⁰ and a majority of the assets of United Grain, LLC and Keller Grain, Inc. in October 2014.¹¹ These assets increased ANDE’s storage capacity and increased their grain production capacity.

Grain: ANDE will continue their acquisition strategy in this segment. As record harvests continue, grain storage revenues increase for ANDE.¹² However, large harvests reduce commodity prices (and ANDE’s revenues), overtaking the gains from storage demand.

Ethanol: In an environment of low crop prices, ANDE has been able to maintain margins in their ethanol group, but low oil prices make gasoline a more attractive substitute for consumers. ANDE’s sales will suffer in 2014 and 2015, but as oil prices increase, the ethanol group will become a growth driver.

Plant Nutrient:  While the plant nutrient group has seen historically low sales compared to the grain and ethanol groups, it contributes almost one quarter of the profit.¹³ As crop producers work to meet the RFS goals and world food demands, the need for plant nutrients will grow. Low costs in this segment will enable the plant nutrient group to be a growth driver in the future.

Rail: The rail group suffered due to recent trends. First, domestic oil producers generate stiff competition for rail lines.¹⁴ Their increased demand for rail space makes it expensive for ANDE’s rail group to operate. The other important trend is the increased use of rail by other sectors. In past years, growing oil prices made rail transport a cost efficient alternative for shipping consumer goods.⁴ As oil prices increase to normal levels, demand for rail transport will increase, hurting ANDE’s opportunities in this segment.

Turf and Specialty: ANDE announced plans to combine the turf and specialty section with the plant nutrient group in 2015.¹⁵ Working as part of the plant nutrient group will benefit the turf and specialty group by decreasing its cost of production and distribution.

Retail: While the retail group is a small section of ANDE’s business, they are a solid performer for the company.¹³ Expect this segment to continue growing in the future.

Economic Analysis

Interest Rates: ANDE took advantage of low interest rates by financing their growth with debt.¹³ As interest rates normalize, the company may need to use other options to finance their acquisitions. For investors, this means flat or lower dividends in the future, or an issuance of shares.

World Food Demand: Global population growth will drive an increase in food demand.⁶ However, two years of record production have created a grain surplus. For ANDE, lower grain production means higher commodity prices and profits. Expect production levels to slow in 2016 as producers react to the surplus.

Oil Prices: Global demand for oil has slowed in recent months, but as economies in China and Europe recover, their oil demand will return to normal levels. As stated above, higher oil prices benefit the ethanol group’s revenues. As we approach the 36 billion gallon RFS biofuel goal, subsidies will decline and ANDE’s margins will suffer.⁶

Industry Analysis

ANDE falls in the agribusiness industry, but they show characteristics of other industries including the corn, wheat, and soybean wholesaling industry and the rail transportation industry.

              

The crop wholesaling industry was volatile in the five years to 2014 (largely due to changing crop prices.) Wholesalers pass on increased costs to downstream markets, and an increase in corn price is a positive driver for this industry.¹⁶ Alternatively, low corn and bean prices hurt revenues in the industry. The aforementioned grain surplus will lead to decreased demand in 2014 and an industry-wide revenue decline of 3.5%.¹⁶

               

Livestock and biofuel production are two demand drivers for the industry and ANDE.¹⁶ Livestock producers’ demand for soybeans and corn is not likely to change in the future, but the recent decline in biofuel demand has driven ethanol prices down.¹⁷ Until oil prices return to normal levels, the decreased demand for biofuels will negatively affect the wholesaling industry.

              

In the rail transportation industry, increased domestic oil production forced rail operators to allocate more cars to oil from 152,676 class 1 carloads in 2012 to 299,652 in 2013.¹⁸ The expected increase in consumer goods shipment and domestic oil production will raise revenues for those in the rail transportation industry.⁴ However, grain transporters must compete with oil and consumer goods producers for rail space. The competition will increase costs of rail transportation and decrease in revenues for grain shipment companies.  

              

Markets and Competition

The two titans of the agribusiness and grain wholesaling industries are Archer Daniels Midland Company (ADM) and Cargill, Inc. Combined, they account for 51% of the market share.⁶ Cargill is the industry leader with annual revenues over $141 billion for 2013. They benefit from economies of scale, outperforming the industry with low production costs. ADM, whose annual revenues were around $90 billion for 2013, has also decreased costs since 2010. Analysts project flat revenues for both companies in 2014 due to the low crop prices.⁶ The industry’s consolidation trend could make ANDE an acquisition candidate for one of the larger companies.⁶

 

Forecasts/Investment Outlook

Revenue Growth: Q4 2014 revenues of$1.33 billion will result in total revenues of $4.6 billion in 2014 (an 18% decline since 2013.) Increasing oil prices in 2015 will drive a strong performance in ANDE’s ethanol group. Revenues will increase 1% to $4.64 billion as a result. In the years following 2015, adjusted crop production will result in 3% growth per year.

P/E Model: Using Bloomberg’s industry P/E ratio of 14.18 and a dividend of $0.44 per share results in a $38.89 price. In an environment of increasing interest rates, ANDE will have to slow dividend growth or issue stock to pay for future acquisitions or expansion. A $0.44 dividend is expected in 2014, but ANDE will have to decrease dividends in 2015 to continue their acquisition strategy. As a result, the price for this model is likely an over-estimate.  

Discounted Cash Flow: The DCF model for ANDE results in a $29.94 price. A sensitivity analysis highlights the importance of the long-term growth rate in this model. The recommended 3% long-term growth rate resulted in the $29.94 price, and a 6% rate results in a $50.95 price. Howevever, a 3% long-term growth correlates more closely to the projected industry growth of 1-3%.⁶

 

Dividend Discount: The DDM results in a $58.52 price. Projected dividends are expected to correlate with the 3% growth rate, but changes in interest rates will influence ANDE’s dividend schedule. As a result, this is also an over-estimate.

Investment Negatives

Commodity price sensitivity: Almost all of ANDE’s business groups are subject to oil or grain prices. Decreasing corn prices have slowed the company’s growth in 2013 and they will have a similar affect in 2014 and 2015.

Oil production and oil price sensitivity: Both the ethanol and rail groups are negatively impacted by increased domestic oil production. Trends for domestic oil production show no signs of slowing, and this hurts ANDE’s investment outlook.

Debt: ANDE has historically maintained high debt-to-equity ratios. The low interest rates in the U.S. enabled ANDE to secure financing at low cost. However, as the Federal Reserve begins to normalize interest rates, ANDE will have to shift their financing strategy.

Investment Positives

High ROE and ROIC: While ANDE maintains a high level of debt, they have a high return on equity and return on invested capital compared to the industry and industry leaders.⁸

               

Acquisition history: ANDE’s acquisition history highlights their desire to grow. With the increase in cash for 2014, they have an opportunity to grow through acquisition in 2015.¹⁹

Returns to investors: ANDE paid dividends for 72 straight quarters, and their dividends reflect consistent growth. While their cash reserves may enable them to continue their dividend increases, ANDE is able to generate positive returns for investors with decreased dividends because of their investing success.

References:

1. Wilson, Jeff. “Soybeans Slump Most in Four Months as U.S. Harvest Accelerates” Bloomberg. 04 November 2014.
2. Krauss, Clifford. “Despite Slumping Prices, No End in Sight for U.S. Oil Production Boom” New York Times. 17 October 2014.
3. Ruitenberg, Rudy. “Oil Seen as Main Driver of Ethanol and Grain Prices in UN Study” Bloomberg. 13 December 2013.
4. IBISWorld – Rail Transportation, 2014.
5. The Andersons, Inc. 2012 10-k report
6.  IBISWorld – Agribusiness in the U.S., 2014.
7. The Andersons, Inc. fact sheet: http://www.andersonsinc.com/wps/wcm/connect/117004804a382d86a0b4ff7856e61bc3/14FactSheet0314_web.pdf?MOD=AJPERES&downloadable%20.pdf
8. Data from Bloomberg
9. Company press release, 09 December 2013.
10. Company press release, 08 October 2014.
11. Company press release, 17 October 2014.
12. Singh, Shruti Date and Wilson, Jeff. “Record Corn Fills Silos While Eroding Farmer Prices: Commodities” Bloomberg. 17 September 2014.
13. The Andersons, Inc. 2013 10-k report
14. Stebbins, Christine. “Record U.S. Corn Harvest a Pile of Troubles for Grain Handlers” Reuters. 06 October 2014.
15. Company press release, 17 November 2014.
16. IBISWorld – Corn, Wheat & Soybean Wholesaling in the U.S., 2014.
17. USDA data, 14 November 2014.
18. “Moving Crude Oil by Rail” Association of American Railroads. December 2013.
19. The Andersons, Inc. 2014 Q4 10-q report