Demand for Food, Not Ethanol, Favors ADM's Stock

Why the snub? Ethanol profits during the quarter were sharply lower. Forget that less than 8% of Archer Daniels' profit comes from ethanol, or that the company's agricultural services, oilseeds, wheat and cocoa businesses have never made more money. Forget too that if you subtract ethanol's entire contribution, remaining profits still beat Wall Street's forecast. Analysts made their obsession clear during the company's conference call. Nearly four in 10 questions related to ethanol.

The ethanol profit decline was driven largely by — see if you can spot the irony here — high oil prices. In theory, dear oil should send consumers clamoring for biofuels, making them more profitable. But that's only true if the crop you're using isn't nearly as oil-thirsty as the car you drive. As this column has pointed out in the past, it takes nearly three-quarters of a gallon of crude to produce a gallon of ethanol from corn, by the time you're done fertilizing, harvesting and cooking the stuff. For comparison, Brazil makes a gallon of sugar fuel with just a pint of crude, or enough to fill one of those Ben & Jerry's ice cream containers.

This week's tumble aside, Archer Daniels stakeholders surely have few gripes. I recommended the stock at $10 and change in February 2003 and at $24 in November 2005. Today shares fetch about $43, recall. The run-up is supported by record profits, though, and so the stock price still seems reasonable. Archer Daniels goes for 15 times forecast earnings for its fiscal year ending June 30. That's about the market's price. Next year analysts foresee the company increasing its profits by a healthy 13%.

The company turned up recently in our Foxhole screen, which looks for stocks that tend to hold up well when the market dips. Shares carry a "beta" of around 0.6, which means they've been only a little more than half as volatile as the S&P 500 index over the past three years. Soaring prices for crops and fuel would seem to make the stock riskier now than in the past. But mostly the company's increased fortune is a result of higher world demand for food, and not the higher cost of it. If, say, America's next farm bill strips tax incentives for corn-for-fuel programs (a wise move, in my opinion), demand for ethanol might shrink, but so might corn prices. That would give a margin boost to other struggling Archer Daniels operations, like turning corn into sugar to sweeten sodas and such.

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