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EQUITY RESEAR
Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors shouldbe aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companiecovered in this report, at no cost to them, where such research is available. Customers can access this independent research awww.lehmanlive.com or can call 1-800-2LEHMAN to request a copy of this research.
Investors should consider this report as only a single factor in making their investment decision.
PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 53 AND IMPORTANT DISCLOSURES BEGINNINON PAGE 54
1
Please also see our industry note (230 pages) published concurrent with this company-specific note.
August 13, 2008
Bunge Limited (BG - US$ 90.85) 3-UnderweightInitiation of Coverage
Finding Shelter?
Investment Conclusion
We have initiated coverage of Bunge Limited (BG)with a 3-Underweight rating, based on our near-to-intermediate term macro view and a relativevantage across the grain and protein processorswithin our universe of agribusiness stocks. Our$97 price target is predicated on a multiple of14.5x our mid-cycle EPS estimate of $6.69 -- a35% premium to BGs historical mid-cycle multipleof 10.8x to primarily account for a number ofpotential points of insulation (geographic and end-product diversification) that could help sustainBGs earnings at levels markedly above what wedconsider "normalized." That said, against verydifficult YoY comparisons (particularly in fertilizer)and with BG trading more than a full standard
deviation above its historical mid-cycle P/Emultiple, we do anticipate increased investor focuson macro headwinds, including risks to animalfeed demand (particularly in North America) andpotential demand destruction in other endmarkets.
Christopher M. Bleds1.212.526.78
[email protected], New Y
United States of Ameri
Consum
Agribusiness Processo
Reuters BG
Bloomberg BG
ADR
EPS (US$) (FY Dec)
2007 2008 2009 % Change
Actual Old New St. Est. Old New St. Est. 2008 20091Q 0.05A 2.10A 2.10A N/A N/A 2.86E N/A 4100% 36%2Q 1.35A N/A 4.73A N/A N/A 4.26E N/A 250% -10%3Q 2.72A N/A 3.46E N/A N/A 3.38E N/A 27% -2%4Q 2.25A N/A 2.71E N/A N/A 2.52E N/A 20% -7%
Year 6.45A N/A 13.00E N/A N/A 13.01E N/A 102% %
P/E 7.0 7.0
Market Data
Market Cap (Mil.) 11047
Dividend Yield 0.77
52 Week Range 135.00 - 80.73
Financial Summary
Revenue TTM (Mil.) 49035
Stock Overview
BUNGE LIMITED - 8/ 13 / 2008
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug
Source: LehmanLive
82.5
97.5
112.5
127.5
Volume
10M
Stock Rating Target Price
New: 3-Underweight New: US$ 97.00Old: 0-Not Rated Old: N/A
Sector View: 1-Positive
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Bunge Limited (BG - $90.85; 3-Underweight)
We have initiated coverage of Bunge Limited (BG) with a
Underweight rating, based on our near-to-intermediate term mac
view and a relative vantage across the grain and prote
processors within our universe of agribusiness stocks. Our $
price target is predicated on a multiple of 14.5x our mid-cyc
EPS estimate of $6.69 -- a 35% premium to BGs historical mi
cycle multiple of 10.8x to primarily account for a number
potential points of insulation (geographic and end-produ
diversification) that could help sustain BGs earnings at leve
markedly above what wed consider normalized. That sai
against very difficult YoY comparisons (particularly
fertilizer) and with BG trading more than a full standa
deviation above its historical mid-cycle P/E multiple, we
anticipate increased investor focus on macro headwinds, includi
risks to animal feed demand (particularly in North America) a
potential demand destruction in other end markets.
In our view, the longer-term dynamics for global, well-capitaliz
grain processors, particularly BG, appear quite favorable a
firmly supported by a robust worldwide consumption and cr
production outlook. Furthermore, the recent pullback in mid-cyc
valuation and possible above-Consensus EPS results in the balan
of fiscal 2008 may lend some support to the shares at curre
levels.
Importantly, however, in the near-to-intermediate term, tcombination of possible demand destruction in animal feed a
potentially other end markets for grains points to a slowing ra
of EPS growth in FY09, in our view. While it remains early da
for evidence of broad-baseddemand destruction, we have seen cle
indications of this within certain end-markets. Specificall
cutbacks by protein producers in North America appear to be taki
hold more firmly, easing volume growth and pricing power of grai
derived animal feed products (corn and soybean meal) a shi
that we believe could gain momentum in coming quarters. And, wi
our analysis suggesting that other important growth drivers oug
to be closely monitored, like dietary shifts in the developin
world, we believe BG could well be on tap for a slowing rate
EPS growth into 2009.
Closer in, we view BG as somewhat better insulated than oth
processors from potential US crop risk a function of its produc
and geographic diversification. Despite more recently improv
growing conditions in the Midwest, we expect the combination of
shallow roots attributable to excessive early season moisture a
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2) heightened risk of frost-related crop damage (and of su
optimal photosynthesis) owing to a protracted harvest season,
keep investors focused intently on crop development in comi
months, particularly as such concerns could increase the resolv
of vertically integrated protein processors to maintain the
production cutbacks. Should we see a return of supply-driv
inflationary pressures through the US harvest season, we estimathat upwards of 36% of BGs oilseed processing asset network cou
be directly exposed to adverse utilization implications a
possible demand destruction, but wed also expect BGs oth
geographies, particularly South America, to see a benefit b
filling this void. In addition, higher grain and oilseed prices
irrespective of whether its supply-push or demand-pull driven
should prove a positive for fertilizer application rates.
Still, while BG may prove fairly well insulated in such a scenari
and wed note a reversal in grain prices would likely translate t
an easing of working capital constraints, a significant portion
an improving cash outlook already appears to be tagged f
spending behind capacity expansion projects in coming period
While the robust long-term demand outlook would suggest su
spending is warranted, including the planned $2 billion investme
in expansion of local production of phosphate rock a
intermediate fertilizers, it nevertheless limits near-term ca
returned to shareholders. Although our analysis does suggest th
capacity expansion has historically proven a positive for tho
investors with a 5+ year investment horizon, it would also appe
as though agricultural investments are an industry wide phenomen
at their highest level in more than 15 years. Taken together,
believe this ultimately raises the near-term risk, in our view,
step-function increases in capacity that could reverse rece
upward momentum in profit spreads, further inhibiting invest
sentiment on grain processors shares.
With respect to BGs recently announced all-stock acquisition
CPO (expected completion in calendar 4Q), we believe firmly in t
long-term strategic rationale and see revenue/cost syner
opportunities well beyond managements initial guidance of $10
$120 million. Among grain processors, Bunges business model
already one of the best capitalized and largest scale is on
pro forma basis even better capitalized, larger scale, and mo
diversified by both geography (on the margin) and end-mark
(fertilizer, oilseeds andcorn/sweeteners, among others). If
were to assume no change in CPOs fiscal 2009 P&L versus 200
plus factor $120 million of cost synergies, wed look for t
acquisition to be net neutral to BGs EPS by the end of fisca
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2009. Still, the combination of the acquisitions price tag
premium multiple, at least at the time, at a peak cycle?) a
possible corn co-product risk in 2009 appear to have temper
near-term investor enthusiasm for the combination, in our view,
these headwinds, if they materialize, could push back t
accretion/dilution timetable absent incremental cost synergies.
All in, we believe company-specific points of insulation (the
are several) could limit significant downside in BGs shares, bu
a premium mid-cycle earnings multiple versus ADM likely reduc
investor tolerance for even marginal evidence that such offse
may be inadequate against potential macro headwinds. In t
following pages, we take a closer look at key points of insulatio
provided by BGs product lines and geographies, and therefo
risks to our rating.
Risks to Our Rating: Key risks to our rating include continu
strength in global demand trends for BG's food, feed an
fertilizer products, including a reversal in BRL strength whi
would enhance the competitive position of BG's Brazilian-bas
agricultural products. More specifically
Capacity could remain tight: Oilseed crushing and tradition
corn milling capacity has tightened significantly in the pa
decade following several rounds of sector consolidation a
robust global growth trends. To the extent that th
consolidation has indeed created a more rational environme
and grain/oilseed processors are therefore willing to igno
expansionary market signals, then above-trend profitabili
could prove more sustainable than implied by curre
expectations.
Protein production cuts could prove too shallow or short-liv
to impact grain demand: Given feed-to-liveweight conversi
ratios of 2x-8x in commercial farm animals, we view BG
profitability as intricately connected to demand for soybe
meal and corn feed. If protein processors fail to take t
necessary measures to return profitability to normalized leve
via supply contractions, then demand for BGs feed produc
could lend to better than anticipated volume and profitabili
in the companys grain and oilseed processing businesses.
Recent sell-off may cause the shares to rally on evidence
sustainability of above-average performances: On a year-to-da
basis, BGs shares have underperformed the S&P 500 by
percentage points (-21% vs. -11%, respectively), pushing t
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shares to 1.3x book value, or one full standard deviation bel
its historical 1.8x book value multiple and not far from i
prior trough of 1.1x. To the extent that current valuati
levels already discount potential FY09 headwinds and concer
about sustainability beyond FY08, we believe evidence to t
contrary could cause the shares to rally.
Savvy hedging strategies may insulate profitability:
regularly uses its in-house crop expertise and global presen
to take proprietary trading positions, which can insulate t
company from headwinds that may otherwise have adverse
impacted its business units. Transparency around the
positions is limited and could create an upside earnin
surprise in any given quarter.
Global market dislocations in response to protectionist
nationalist government policies could continue to create mark
share and arbitrage opportunities: BGs global ass
infrastructure, coupled with the assets of its JV partner
have been well positioned to capitalize on market dislocatio
stemming from border closures and protectionist measures
certain regions of the world. While generally these have be
viewed as non-recurring dislocations, we believe another st
function increase in agricultural commodity inflation could s
off another round of policy changes, with additional favorab
implications for BGs agricultural services functions.
The US government may opt to alter its subsidization of corn
based ethanol: We believe the highly inflationary environme
of the past twelve months has increased political pressure
US government officials to repeal or reduce various suppor
provided to the corn-based ethanol industry. Should su
changes include a reduction in the sugar-based ethanol impo
tariff, wed expect BGs expanding sugar presence to direct
benefit from increased demand, while its sizable Brazili
agricultural asset infrastructure could see a further indire
benefit from improved utilization levels. Likewise, pro for
for its acquisition of CPO, we believe profitability in co
sweeteners businesses could improve under such a scenar
(hedges aside), as more corn becomes available (presumably at
less expensive cost) for non-energy related uses, while cor
based sweeteners a substitute for sugar -- become mo
competitive globally in response to likely inflationary sug
trends.
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Fertilizer profitability may remain above-average for t
foreseeable future: In our view, aside from BGs geograph
fertilizer advantage, which we estimate translates to a $40-$
per metric ton transportation advantage in catering locally
expanding acreage and application trends in South America,
also believe BGs vertical integration in phosphate-bas
fertilizers could help bolster the sustainability of abovtrend profitability in this business given the high cost a
lengthy duration of Greenfield expansion projects in phosphat
based fertilizers.
BG Potential 09 Macro Headwinds, but Better Insulated than Some
In our view, against a backdrop of tight industry capacity, BG
diversified model has positioned the company quite favorably as
beneficiary of the robust global consumption environme
experienced in the past several years. However, this diversifi
model also exposes BG to certain macro-level risks, which anticipate will draw increased investor focus in coming quarters
Looking into 2009, we believe record prices for grain
exacerbated by supply-side shocks like flooding in the Midwest a
a late start to the growing season, raise the need for pas
through pricing and therefore create risk of broad-based dema
destruction for certain end-products, particularly fe
consumption and emerging market food consumption. By extensio
although increased raw material costs tend to create market sha
opportunities for BG relative to less well-capitalized players,
raises working capital requirements and deteriorates certa
credit measures (something that CPOs clean balance may help
address). Nevertheless, we expect demand destruction in grains
negatively tilt the bias of earnings growth in 2009, placi
disproportionate reliance on better insulated geographies (e.g.
America, an admittedly big business for BG) and business lin
(e.g. trading and/or fertilizer, also a big business for BG)
maintain the pace of earnings growth on a consolidated basis.
All in, incrementally less bullish investor sentiment has weigh
on the shares of grain processors. Still, we feel that BG
business lines and geographic exposure relative to peers off
more specific points of insulation (greater percent of reven
from S. America and fertilizer) even against what could prove
be meaningful headwinds: potentially less robust corn co-produ
margins in 2009 (assuming approval of the CPO acquisition), dema
destruction taking hold in North American animal feed, reduc
processing utilization levels in the US related to a likely low
tonnage harvest, and worldwide industry capacity expansion.
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Figure 1: BG - Agricultural Merchandising, Processing, Food Products and Fertilizer
Asset Footprint
Merchandising Processing
Owned Leased Total Owned Leased Total Metric Tons (M) Met Tons (M) / Yr
Company Total (excluding CPO)
North America NA NA NA NA NA NA 7.055 21.9Rest of World NA NA NA NA NA NA 14.178 91.8
Worldwide NA NA 307 NA NA 157 21.563 113.6
Agribusiness*
Processing (Oilseed, Wheat and Corn)
North America NA NA NA NA NA NA NA NA
Rest of World NA NA NA NA NA NA NA NAWorldwide NA NA 302 NA NA 56 17.335 46.2
Fertilizer**
Mining & BlendingNorth America NA NA NA NA NA NA NA NA
Rest of World NA NA 4 NA NA NA NA NAWorldwide NA NA 4 NA NA 44 3.347 55.7
Food Products
Segment Total (Disclosed)
North America NA NA NA NA NA NA NA NARest of World NA NA NA NA NA NA NA NA
Worldwide NA NA 1 NA NA 57 0.881 11.7
BG's Additional Lines of Business
*Agribusiness
Sugarcane mill and ethanol plant (Brazil) and Sugar Trading platform
Minority investor in biodiesel producer Diester Industries Int'l (Europe)
Financing intermediary for farmers (Brazil)
**Fertilizer
Controlling stake in Fosfertil (Catalao, Tapira and Salitre Brazil mines, w/ 1m, 300k, and 500k MT of capacity/yr)
Other: Corn Products Int'l (acquisition pending approval)
Merchandising Processing
CapacityFacilities
Source: Company filings and Lehman Brothers estimates
Diversified Model Exposes BG to Potential NT Macro Headwinds
Below, we discuss several key watch points which we believe wi
draw increased investor focus in coming quarters, with possib
implications for Bunge. These include: 1) inflation-induced dema
destruction in key markets, 2) a lower tonnage US harvest as
result of early summer flooding / crop rotation with utilizati
implications for North American processing assets (less tonna
produced), and 3) step-function increases in industry capacity
grain/oilseed processing as well as fertilizer production.
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Figure 2: Key Macro Events/Themes in Agriculture and Potential Implications for 2009
Major Theme Where When Implications Explanation/Significance +/- in '09 for Line of Business* Potential P&L Impact
Crop Rotation N. America Spring '08 Corn to Soybeans crop rotation necessary for health of soil
Harvest Less Tonnage in Fall '08 soybeans yield fewer bushels per acre than corn - N.A. Ag Services Lower Volume- N.A. Corn Processing Lower Volume+ N.A. Soybean Processing Higher Volume
Prices: Higher Corn / Lower Soybean less corn supply, more soybean supply - N.A. Corn Processing Lower Margin+ N.A. Soybean Processing Higher Margin
Less Fertilizer Used in Spring '08 soybeans require less fertilizer than corn + N.A. Fertilizer Easy YoY Comparison
Implications for S. America: reliance on SA corn increases + S.A. Corn Processing Higher Volume, Margin
reliance on SA soybeans decrease - S.A. Soybean Processing Lower Volume, Margin
Excess Precipitat ion N. America C'1H08 Limited Farmer Access to Fields too wet for equipment to work effectively
La te Start to Pl antings Vo lum e: Rotati on from Corn to Soybean less corn supply, mo re soybean supply - N.A. Corn P rocessing Lower Volumecorn g rowing season sta rts ear lier than soybean + N. A. Soybean Process ing Higher Volumesoybeans yield fewer bushels per acre than corn - N.A. Ag Services Lower Volume
Volume: Soybean Plantings Also Limited excess rain / limited availability of rust resistant seeds - N.A. Soybean Processing Lower Volume
Prices: Higher Corn / Higher Soybean less corn supply, less soybean supply in US - N.A. Corn Processing Lower Margin- N.A. Soybean Processing Lower Margin
Demand shift to South America Reliance on SA soybeans/corn increase + All S.A. Processing Higher Volume, Higher Margin
Floods after Emergence High W ater Levels Create Risk to Floodwalls barge capacity reduced (increases '08 barge rates) - N.A. Ag Services Difficult YoY Comparison
Reapplication of Fertilizer (Modest) fertilizer may have been reapplied where feasible - N.A. Fertilizer Difficult YoY Comparison
Demand shift to South America Reliance on SA soybeans/corn increase + All S.A. Business Lines Higher Volume, Higher Margin
Market Dislocat ions Global C'1H08 Margin & Market Share Opportunit ies heightened concern around distr ibut ion/access
Distribution Re-Routing / Availability Concerns pricing power on long-haul utilization, availability concerns - Ag Services Difficult YoY Comparison
Abitrage Opportunities local market info provides edge on global commod trading - Trading Difficult YoY Comparison
Inflation Global** C'2H08-09 Demand Destruction inability of grain-procurers to remain profitable
Grain Inflation Protein Production Cuts feed conversion ratio = 2x-8x depending on protein - All Global Business Lines Lower Volume, Lower Margin
Watchpoint Risk to Emerging Market Food Consumption higher elasticities than developed world food consumption - All Global Business Lines Lower Volume, Lower Margin
General Inf lation N. America Watchpoint Fed Tightening Cycle (USD Strengthening) makes US commodities less competi tive globally - A ll N.A. Business Lines Lower Volume, Lower Marginmakes S. Amer ican commodit ies more a ttr ac tive + Al l S .A . B us iness L ines Higher Vo lume, Higher Marg in
S. America makes S. American commodities more attractive + All S.A. Business Lines Higher Volume, Higher Margin
Capacity Expansion Global** Watchpoint Processor Competition asset expansion = step-function capacity increases - All Lower Margin
*Assumes no hedges in place
**Global, but N. America is major global protein supplier
Source: Lehman Brothers analysis
Risk #1: Potential inflation-induced demand destruction in k
markets: In our view, markets with traditionally high elastici
levels remain the most at risk in todays elevated commodity pri
environment. In particular, we view North American fe
consumption and developing market food consumption as most
risk, posing potential adverse implications for BG.
North American Feed Consumption: BG CEO Alberto Weisser comment
at an industry conference in June that the company was beginni
to see weaker feed demand in North America. ADM followed su
with similar commentary on its fiscal 4Q08 conference call
August 5th. Animal feed accounts for more than 40% of total co
and soybean consumption in the US, clearly an important end-mark
for grain processors serving the US market. By our math, t
companys Agribusiness unit accounts for roughly 45% of normaliz
EBIT and houses its oilseed processing assets. If we were
assume that two-thirds of BGs oilseed processing capacity
allocated to protein meal (and the majority of this to anim
feed), we estimate that roughly 30% of company-wide profitabili
is potentially exposed to animal feed elasticity headwin
globally. However, only 36% of the companys oilseed processi
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capacity is located in North America, implying total exposure
11% of company-wide profitability.
Figure 3: BG Estimated Exposure to North American Feed Operations
Figure: BG - % of EBIT (Normalized) Figure: BG - Processing Capacity Figure: BG - NA Feed Exposure
N.America
Feed,24%
All Other,76%
Other,
55%
Processi
ng, 45%
N.America
Feed,11%
All Other,
89%
Source: Lehman Brothers estimates
To put this into context, simply looking at the level of prote
production cuts currently implied by forward looking indicato
(egg sets, sow slaughter, and cattle on feed), and taking in
account weight reductions, we calculate that the US prote
industry is on tap to reduce total meat production by nearly -6
effectively reducing total meat production from 67.2 billi
pounds of retail weight to 63.3 billion pounds i.e. a -3
billion pound reduction, led by pork (-2.1 billion pounds), th
chicken (-938 million pounds) and then beef (-813 million pounds
assuming current forward looking indicators hold (see analys
below). If we were to apply the -6% protein production cut
this 11%, we estimate that it would create a utilization gap
less than 1% of BGs total company-wide processing capacity
smaller than the estimated 1.5% gap for ADM. Still, the glob
nature of these commodities can present implications for non-
geographies, in our opinion.
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Figure 4: Corn & Soybean Demand Destruction Related to Animal Feed (Tonnage and
Acreage Implications)
US Consumption % of Production Reduction(M lbs.) Consumption Cut Basis in M Lbs.
Chicken 31,594 47% -3.0% eggs set (-4.2%), weight (+1.2%) -938Beef 18,071 27% -4.5% cattle on feed (-4.1%), weight (-0.4%) -813Pork 17,556 26% -12.4% sow slaughter (+11.9%), weight (-0.5%) -2,183
Combined 67,221 100% -5.9% weighted average -3,934
Reduction Feed Conv.in M Lbs. Ratio Corn Soy Corn (M lbs.) Soy (M lbs.) Corn (M bu.) Soy (M bu.) Corn Soy Combined
Chicken -938 2.7 67% 33% -1,702 -838 -30 -14 -0.2% -0.5% -0.3%Beef -813 12.9 67% 33% -7,009 -3,452 -125 -58 -1.0% -2.2% -1.2%Pork -2,183 4.6 67% 33% -6,779 -3,339 -121 -56 -0.9% -2.2% -1.1%
Combined -3,934 5.9 -15,490 -7,629 -277 -127 -2.1% -4.9% -2.6%
Corn Soy Corn Soy Corn Soy Combined Corn Soy Combined
Chicken -30 -14 151 41 -0.20 -0.34 -0.54 -0.2% -0.5% -0.3%Beef -125 -58 151 41 -0.83 -1.40 -2.22 -0.9% -2.2% -1.4%Pork -121 -56 151 41 -0.80 -1.35 -2.15 -0.9% -2.1% -1.4%
Combined -277 -127 151 41 -1.83 -3.09 -4.92 -2.0% -4.9% -3.1%
*% of US Production based on 2007 production of:
US Production (Million Bushels)
Corn 13,074
Soybeans 2,585
Combined 15,659
**based on '07 avg yields
***% of US Acreage based on '07 Planted Area
US Production (Million Bushels)
Corn 93.6
Soybeans 63.6
Combined 157.2
Feed Mix % of Total US Production* (tonnage)Implied Chg in Feed Demand
% of Total US AcreageChg in Feed Demand (M bu) Bushels/Acre** Acreage Reduction (M)
Source: Lehman Brothers analysis
Given the time lag implied by the forward looking indicators us
in this analysis, wed expect most of this reduction to come
fruition in 2009. As illustrated below, we have already begun
see cutbacks in herds and livestock put into motion even befo
the most recent rise in feed related to flooding in the Midwes
which in our view likely accelerated cutbacks. Importantly, th
has implications not only for protein pricing, but also for dema
for crops. Taking into account factors like feed-to-prote
conversion ratios for commercial farm animals, the mix of fe
represented by corn and soybeans, and average yields per acre,
estimate that the aforementioned -6% decline in protein producti
would, in a vacuum, result in a -2.6% decline in tot
corn/soybean tonnage consumed and a -3.1% decline in total
acreage required. Interestingly, this decline is rough
equivalent to the +3.2% increased acreage requirement between 20and 2008 necessary to satisfy ethanol mandates. In a vacuum, o
supply/demand models suggests that this decrease in acrea
requirement would translate to a $0.35/bushel decrease in the co
of corn and roughly a $3/bushel decrease in the cost of soybe
meal.
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Figure 5: Eggs Set - 10-Week Forward-Looking Chicken Supply
Data
(YoY % Change)
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
02 Wk 30 03 Wk 30 04 Wk 30 05 Wk 30 06 Wk 30 07 Wk 30 08 Wk 30
Source: USDA National Agricultural Statistics Service
Figure 6: Boar & Sow Slaughter 9-mo Forward-Looking Pork
Supply Data
(YoY % Change)
200
250
300
350
400
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008 2007 2006
Source: USDA National Agricultural Statistics Service
Figure 7: Cattle Place on Feed 6-mo Forward Looking Beef
Supply Data
(1,000 head)
0
500
1,000
1,500
2,000
2,500
3,000
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008 2007 2006
Source: USDA National Agricultural Statistics Service
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Developing Market Food Consumption: BG is more closely link
today to food consumption in the developing world, especially mu
of Asia, than at any time in its history (see below).
Figure 8: BGs Global Asset Network and Businesses (2008 vs. 2001)
2001 2008
Source: Bunge Limited presentation (June 2008)
Given the more favorable environment for crop production in Nor
America and South America relative to Asia (see rainfall levels
figure below and left) as well as Asias faster population grow
and more robust per capita GDP trends (changing diets below an
right), BG has capitalized on its extensive global reach
connect its processing assets (concentrated most heavily in t
Americas) with this growing source of demand. Likewise, BG h
made further inroads by bringing the asset base closer to t
demand via Greenfield expansion, acquisition, and joint ventures
Figure 9: Worldwide Rainfall Figure 10: Global Dietary Shiftpropor tion of w orldw ide prec ipitati on
proportion of all people living on US $10 -$20/ day of purchasing p ower parity
Copyright 2006 SASI Group (University of Sheffield) and Mark Newman
(University of Michigan)
Source: Worldmapper.org
Copyright 2006 SASI Group (University of Sheffield) and Mark Newman
(University of Michigan)
Source: Worldmapper.org
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While we view this push into faster-growth markets as
significant long-term positive for BG, we nevertheless acknowled
that such exposure is not without risk, particularly given the
markets historically high demand elasticity levels relative
consumption in the developed world.
In developing markets, the combination of a dietary shift to mocalories, more meat-based calories, and population growth h
fueled demand for grains. As discussed previously in this repo
and again in more detail later (see Supplement and Append
sections), we believe the health of per capita GDP trend
particularly among BRIC countries (Brazil, Russia, India a
China) is an important watch point for investors in gra
processing stocks. On this score, we note that several BR
countries have already exceeded the duration of their historic
economic expansionary period. And, in our view, although emergi
markets still only make up a fraction of total demand relative
domestic consumption, the influence of per capita GDP trends a
inflation is nevertheless magnified as a result of higher dema
elasticity for food than in the United States. Whereas a
increase in general consumer inflation leads US consumers to c
back consumption of grains and meat by a mere 0.04% and 0.09
respectively, consumption in BRIC countries is more than 5x
sensitive, according to a study by the USDAs Economic Resear
Service.
Accordingly, applying historical grain and meat elasticity rat
to current inflationary pressures in each of the four BR
countries is equivalent to returning roughly 3.5% of total wor
corn and soybean production (or 10% of US production) back on
the market (see Figure: Protein Production Cuts Ease Gra
Requirements in the pages below). In addition, if we were
assume an average correction to per capita GDP trends of the fou
BRIC countries and apply the historical elasticity rates, w
calculate that this would have the equivalent effect of returnin
4.0% of the worlds total corn and soybean production (roughly 1
of US production) back onto the market (see figure below
Appendix for complete analysis).
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Figure 11: Equivalent % of World Corn & Soybean Production Returned to the Market
Assuming
Historical Elasticity Response to Current Inflation Rate
1.1%
0.4%
0.3%
0.9%
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
Brazil Russia India China
Hist. Elasticity Response to Avg Per Cap GDP Correction
1.4%
0.5%
0.4%
1.7%
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.6%
1.8%
Brazil Russia India China
Source: USDA (Economic Research Service) and Lehman Brothers analysis
Risk #2: A sub-par US harvest: Several factors appear poised
deflate US crop production this year, with potential implicatio
for BGs profitability through next year. These factors inclu
crop rotation from corn to soybeans (a lower tonnage per bush
crop versus corn), a late start to the growing season (creatin
risk of frost and/or too little daylight for photosynthes
related to a late harvest), and severe Midwest flooding (some lo
acreage). While it would appear as though the crop has been qui
resilient to early season flooding and excess moisture,
continue to believe that it warrants watching, as there a
several important implications of a weak US harvest and associat
supply-push inflation, including cost pressures (without fu
pass-through pricing power, particularly in ethanol), potenti
demand destruction, system wide working capital constraints, a
impaired utilization levels. Naturally, those processors wi
proportionately fewer assets within the US are better insulate
As noted previously, we estimate that BGs processing capaci
exposure in North America is roughly 36%, or half of ADMs 70
exposure.
Supply-Push Inflation:Although price inflation is generalpositive for grain processors when it is demand-pull driven (s
figure below), it can be considerably less so when the source
inflationary pressures is supply-side led. In the demand-pu
inflation of recent years, BG has sufficiently preserved i
margin structure on the back of strong pricing power (demand f
end-products) and higher utilization levels (spreading fixed cos
over more units), which has allowed the company to offset high
raw material costs.
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Figure 12: BGs Product-Line Exposure (small circles) to Demand-Pull Grain Inflation
(large circle)
Margin Positive Margin Positive
Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose) NPK Fertilizers Chicken Grow-Out Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose)
Milling: Starches (Industrial, Food) Sweeteners Turkey Production Milling: Starch (Industrial, Food), Co-Product (Feed, Meal, Oil)Co-Product (Feed, Meal, Oil) Starches Hog Production Ethanol
Ag Services Co-Products Feedlot Operations Ag Services
Soybean Oil Oil Corn Ethanol Ethanol Soybean Oil
Crushing: Meal Meal Milling: Bio-Diesel Crushing: Meal
Ag Services Ag Services Bio-Diesel
Soybean Bio-Diesel Ag Services
Fertilizer: NPK Blends Crushing: Fertilizer: N/A
Fertilizer: N/A
Poultry & N/A Poultry & Chicken Grow-Out
Livestock Poultry & Poultry & Livestock Producers Livestock Turkey Production
Livestock Protein Processors Hog Production
Feedlot Operations
Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose) Corn N/A Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose)
Milling: Starch (Industrial, Food), Co-Product (Feed, Meal, Oil) Milling: Milling: Starches (Industrial, Food)
Ethanol Co-Product (Feed, Meal, Oil)
Ag Services Soybean N/A Ag Services
Soybean Oil Crushing: Soybean Oil
Crushing: Meal Crushing: Meal
Bio-Diesel Fertilizer: NPK Blends Ag Services
Ag Services
Fertilizer: N/A Margin Negative*** Margin Negative Fertilizer: NPK BlendsChicken Grow-Out Poultry & Non-Vertically Integrated Protein NPK Ferti lizers
Turkey Production Livestock Processing Operations (Beef Sweeteners
Hog Production Packing, Pork Processing) Starches
Poultry & Chicken Grow-Out Feedlot Operations Co-Products Poultry & N/A
Livestock Turkey Production Ethanol Oil Livestock
Hog Production Bio-Diesel Meal
Feedlot Operations Ag Services
* Assumes no hedging and no forward contracting
**Certain circumstances may cause results to vary
***Margin negative unless the product is the source of the inflationary pressure
Bargaining power shifts upstream to growers and to processors of grains. Consumers of grain-derived end
products (feed, ethanol, HFCS) compete for raw material, thereby driving grain prices higher. Global demandfor grain-derived end products leads to high capacity utilization among processors and facilitates pass-through
pricing, except where pricing is determined by unrelated cycles (protein, ethanol).
Bargaining power shifts downstream to the consumers of grain-derived end products. (feed, ethanol, HFCS)
easing competition for raw material, thereby driving grain prices lower. Weak global demand for grain-derivedend products leads to low capacity utilization among processors and impairs pass-through pricing, except
where pricing is determined by unrelated cycles (protein, ethanol).
Adverse Price Driver for
Beneficial Price Driver for Beneficial Cost Driver for
Not a Direct Price Driver for
Not A Direct Cost Driver for
Duration Influenced by: Economic Cycles (Food, Fuel & Industrial Product Demand), Protein Production (Feed Demand), Currency Trends, Gov't Policy
CORN & SOYBEAN GLOBAL DEMAND-DRIVEN PRICE CYCLE (PRODUCT IMPLICATIONS)
Adverse Cost Driver for
Strong Corn & Soybean Demand Weak Corn & Soybean Demand
Source: Lehman Brothers analysis
In supply-push driven inflationary environments (see illustrati
below), bargaining power shifts upstream to surviving growers
grains, as limited raw material availability drives gra
processors to compete for supply, in turn driving grain pric
higher. Still, grain processors can recover some of this co
pressure, as their customers own concerns about the availabili
of grain-derived end-products may facilitate the ability to pas
through higher raw material prices. However, the consumption bi
for grain-derived end-products tilts negatively in such a scenar
given the potential for inflation-induced demand destructio
ultimately threatening to create a less favorable prici
environment among processors competing for fewer contracts.
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Figure 13: BGs Product-Line Exposure (small circles) to Supply-Push Grain Inflation
(large circle)
Margin Positive Margin Positive
Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose) NPK Fertilizers** Ethanol Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose)
Milling: Starches (Industrial, Food) Bio-Diesel Milling: Starch (Industrial, Food), Co-Product (Feed, Meal, Oil)Co-Product (Feed, Meal, Oil) Chicken Grow-Out Ethanol
Ag Services Turkey Production Ag Services (when corn price trend is demand driven)
Soybean Oil Corn Ethanol Hog Production Soybean Oil
Crushing: Meal Milling: Feedlot Operations Crushing: Meal
Ag Services Sweeteners Bio-Diesel
Soybean Bio-Diesel Starches Ag Services (when soy price trend is demand driven)
Fertilizer: NPK Blends Crushing: Co-Products Fertilizer: N/A
Oil
Fertilizer: N/A Meal
Ag Services
Poultry & N/A Poultry & Chicken Grow-Out
Livestock Poultry & Poultry & Livestock Producers Livestock Turkey Production
Livestock Protein Processors Hog Production
Feedlot Operations
Margin Negative Margin Negative
Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose) Ethanol Corn N/A NPK Fertilizers** Corn Sweeteners (HFCS, Dextrose, Glucose, Maltose)
Milling: Starch (Industrial, Food), Co-Product (Feed, Meal, Oil) Bio-Diesel Milling: Milling: Starches (Industrial, Food)
Ethanol Chicken Grow-Out Co-Products (Feed, Meal, Oil)
Ag Services Turkey Production Soybean N/A Ag Services (when corn price trend is demand driven)
Soybean Oil Hog Production Crushing: Soybean Oil
Crushing: Meal Feedlot Operations Crushing: Meal
Bio-Diesel Sweeteners Fertilizer: NPK Blends Ag Services (when soy price trend is demand driven)
Ag Services Starches
Fertilizer: N/A Co-Products Fertilizer: NPK Blends (when corn price trend is demand driven)Oil Poultry & Non-Vertically Integrated Protein
Meal Livestock Processing Operations (Beef
Ag Services Packing, Pork Processing)
Poultry & Chicken Grow-Out Poultry & N/A
Livestock Turkey Production Livestock
Hog Production
Feedlot Operations
* Assumes no hedging and no forward contracting
**Certain circumstances may cause the converse
Bargaining power shifts upstream to surviving growers of grains, as limited raw mat'l drives grain processorsand consumers of grain-derived end products to compete for supply, driving grain prices higher. End-product
demand remains unchanged but utilization suffers. Availability concerns may facilitate pass-through of prices tograin-derived end-products, except for unrelated cycles (protein, ethanol).
Bargaining power shifts downstream to processors of grains and consumers of grain-derived end products.Wide availability of raw material eases competition for grains, driving grain prices lower. End-product demand
remains unchanged but utilization improves. Availability of grain-derived end products may force the pass-through of lower prices, except for unrelated cycles (protein, ethanol).
Adverse Price Driver for
Beneficial Cost Driver for
Not A Direct Cost Driver for
CORN & SOYBEAN DOMESTIC SUPPLY-DRIVEN PRICE CYCLE (PRODUCT IMPLICATIONS)
Beneficial Price Driver for
Not a Direct Price Driver for
Adverse Cost Driver for
Domestic Corn & Soybean Supply Shortage Domestic Corn & Soybean Supply Surplus
Duration Influenced by: Annual Domestic Crop Production (Acres Planted and Yield Per Acre) and Intra-Season International Production
Source: Lehman Brothers analysis
Altogether, while elements of demand-pull inflation appear like
to remain in place (and possibly for quite some time), the nea
term pull from certain end-markets, like protein processors, cou
be more tepid, thus creating a less favorable profit dynamic th
had been in place for much of 2007 and 2008. In addition, we wi
continue to closely monitor crop development through the harve
season for any indication that US grain processing assets mig
also contend with supply-push elements that had not previous
been in place.
Processing Utilization Levels: Likewise, the full adverse effe
on margins is often not realized until the following year, wh
the prior years fall harvest is consumed. With less to harvesthough, the risk to asset utilization levels suffers, eith
because of reduced availability of supplies in affected regions
because of inflation-induced demand destruction more generall
As a result of lower utilization levels and marginally le
pricing power (relative to the pricing power of their farm-lev
suppliers), margin preservation for grain processors becomes mo
difficult to achieve.
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Utilization Levels for Origination Assets: Aside from utilizati
levels for grain elevators, storage facilities and processi
plants, wed note that a poor harvest can create asset utilizati
headwinds for origination assets, like BGs grain elevators.
our view, utilization levels on assets that handle US crops m
suffer in 2009 against a difficult 2008 comparison, as the lar
2007 corn-heavy crop, which came to harvest last fall and currently being marketed, has also propped up demand for capaci
in 2008. In order for these assets to repeat results seen
2008, they will have to overcome the reduced yields resulting fr
flooding and from crop rotation to lower tonnage per ac
soybeans.
Risk #3: Industry-wide capacity expansion: In our view, tig
capacity creates industry pricing power. Conversely, capaci
expansion, in a vacuum, threatens industry pricing power an
creates a possible headwind for profit margin expansio
Accordingly, we believe recent trends in capacity expansion m
give some investors cause for concern.
ADM: For its part, wed note that as of ADMs fiscal 2007 10
filing last summer, it had intended to spend $3.0 billion
capacity expansion and other capital projects through fiscal 20
(June 30 year end). But, as of June 2008, the company indicat
that through March 2010 it expects to have already spent $2
billion of this total, with fiscal 2009 spending representing th
potential peak. Specifically, ADM has indicated that it
expanding its South American barge fleet by 30%, adding 1,800 ta
cars to its fleet of 21,000 railcars, and improving import/expo
capacities. It is constructing two new ethanol plants (C3Q09 a
C1Q10 completion), building a PHA biodegradable corn-bas
plastics plant (C2Q09 completion), expanding its cocoa processi
capabilities (C3Q09 completion), adding a new propylene glyc
plant (C3Q09 completion), and undertaking other capital projec
as well. ADMs construction of two new dry corn milling plan
will increase the companys annual ethanol production capacity
550 million gallons to 1.7 billion gallons.
BG: But, this trend is not unique to ADM. Similar initiatives a
taking place throughout the industry. BG, for instance,
increasing its canola crushing capacity by about 50% (to 1,4
metric tons per day) with the expansion of its Nipawin, Canad
facility. Likewise, the company is expanding its access
fertilizer raw materials, including the Araxa mine expansion (la
2009) and Fosfertil Tapira and Catalao mines (early 2010), whi
coupled with other fertilizer expansion initiatives is expected
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provide BG with a 65% boost in phosphate rock production capaci
by 2011. And, the company is expanding its Santa Juliana Sugarca
Mill in Mato Grasso, Brazil, from 1.6 million metric tons of can
milling capacity to 4 million metric tons. Several other maj
initiatives, namely the build-out of oilseed crushing/refini
facilities spanning four continents, are underway as well.
Industry-Wide: By the numbers, large cap grain processors a
spending more on capacity expansion initiatives (as measured
capital expenditures as a percent of the prior years n
property, plant and equipment asset base) than at any point
time in the last 15 years. As shown below, the industry h
increased its spending on capital expenditures five-fold fr
roughly 5% of the prior years Net PP&E in 2001 to more than 2
estimated in 2008 a clear indication, we believe, of more th
just maintenance capex spending. Also as illustrated below,
believe the reduction in capex (as a % of prior years Net PP&E
during the 1996 to 2001 period helped set the stage for
subsequent recovery in grain processors Return on Assets, whi
tripled from a trough level of 2% in 1999 to 6% in 200
Accordingly, the dramatic rise in capacity expansion in the la
seven years warrants watching as it may pose a risk to indust
returns.
Figure 14: Grain Processors Return on Assets vs. Capacity
Expansion
Source: Company filings and Lehman Brothers analysis
Industry-wide capacity expansion initiatives are not limited
processing assets. Fertilizer capacity is expanding as well. F
instance, in June 2008, Canpotex a consortium led by fertiliz
producers Potash Corp, Mosaic, and Agrium and responsible f
exporting all potash produced in the Saskatchewan province
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Canada -- plans to begin two terminal projects that collective
will provide a two-fold increase (from 12 million tons to
million tons) in its available capacity. While terminal capaci
itself is not a concern to fertilizer profitability, perhaps mo
important is the production intention of the consortium behind t
projects. Canpotex CEO Steven Dechka indicated, "With Canpot
shareholders working to significantly increase production over tnext several years, we have a responsibility to build on our long
term ability to deliver this essential nutrient to offsho
markets. Not surprisingly then, in July Potash Corp. announc
plans for an additional 2.7 million metric tonnes of pota
capacity by 2012, enabled by brownfield expansion at
Saskatchewan plants. Importantly, in our view, the co
efficiency and plug and play nature (with existi
infrastructure) make brownfield expansion an attractive option f
fertilizer producers, which could very well erode fertiliz
pricing power over time.
Figure 15: World Potash Projects vs.
Demand Growth
Figure 16: Brownfield vs. Greenfield
Expansion Costs
based on committed projects including POT's Saskatchewan brownfield expansion
Million Tonnes KCI, Cumulative Growth
0
2
4
6
8
10
12
14
16
2008 2009 2010 2011 2012
POT's Saskatchewan Brownfield
Committed Capacity Expansion Projects4% Demand Growth (4.5% '08 projection)
Billion Dollars per Million Tonnes of Potash
$1.4
$0.6
$-
$0.2
$0.4
$0.6
$0.8
$1.0
$1.2
$1.4
$1.6
green brown
Source: Potash Corp (June 08), Fertecon, and Lehman
Brothers analysis
Source: Potash Corp filing (July 08) and Lehman Brothers
analysis
While the theme of capacity expansion holds true acro
fertilizers, we would note that BGs primary profit exposure (an
vertical integration model) is to phosphate, not potash. In o
view, the higher barriers to entry in phosphate and the duratiof Greenfield expansion, coupled with an increased emphasis
South American production (the primary geography serviced by BG
fertilizer business) may better insulate the company fr
potential margin pressures associated with capacity expansi
initiatives in other fertilizers (see Supplement). Nevertheles
the companys operating margin has expanded from 2.8% in 2005 to
mid-teens level most recently (a long-term average of 10.5%
While it may be some time before we see 2.8% operating margi
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again, we would not be surprised to see margins, over time, com
off of current levels.
Margin Implications: In our view, given the strong long-te
global demand outlook for grain-derived products, we believe th
incremental spending is warranted. But, warranted or no
capacity expansion may threaten near-term industry pricing powand create a possible headwind for profit margin expansion
margin and $ margin). While capacity expansion appears to
firmly rooted in robust global demand projections, we
nevertheless note that the sheer size of the plants and the un
processing capacity necessary to create scale advantages lead
step-function increases in industry capacity rather than
perfectly smooth scaling up along the consumption curve.
Cash Implications: Separate from the potentially adverse marg
impact, construction of new capacity also limits cash returned
shareholders. By our math, as shown below, large cap gra
processors are pouring a larger percent of their free ca
generation into capital expenditures than at any point since 199
With a group average dividend yield of 1.3% (0.8% for BG) versu
the S&P 500 dividend yield of 2.2%, wed anticipate renew
management focus, particularly as working capital requiremen
eventually ease, on striking a better balance between investmen
in long-term projects and cash returned to shareholder
Likewise, with industry-wide capacity expansion at peak levels,
more conservative approach by management may now be warranted wh
evaluating expected financial returns on capacity expansi
projects.
Figure 17: Grain Processor Capex % of
OCF* vs. ROIC
Figure 18: Capex vs. Prior Year PP&E (BG
vs Peers)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Capex%
ofOCF(excl.wkg
cap
chg)
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
RO
A
Capex % of OCF (before Wkg Cap Changes) ROIC
9%
12%
15%
23%
34%
21% 21%
17%
19%20%
9%
11%
13% 13%14%
0%
5%
10%
15%
20%
25%
30%
35%
40%
2004 2005 2006 2007 2008
ADM BG CPO
*Before changes in working capital
Source: Company filings and Lehman Brothers analysis Source: Company filings and Lehman Brothers analysis
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CPOs Co-Product Exposure a Potential 09 Headwind for BG
In our view, the same macro trends that allowed CPO to meet, an
in some cases, handily exceed its five-year financial target
which include low double digit EPS growth and an 8.5%-10%+ retu
on capital employed (ROCE) appear likely to remain intact for mo
of the balance of 2008 (albeit at a moderating pace).
addition, we see the long-term strategic rationale for BG
proposed merger with CPO as quite firm. That said, it appears
us that much of the upside in CPOs results in 1H08 have be
driven by co-product pricing, i.e. the companys policy to lock-
its corn requirements in North America, without capping securin
pricing for many non-starch co-products, like corn oil, corn fee
and corn meal, which collectively make up between 20% and 30%
CPOs revenue. In our view, even with the recent pullback in t
grain markets, co-products may continue to provide YoY upsi
earnings potential through the balance of the year. But, wi
inflation-induced demand destruction already taking hold in animfeed (11% of CPOs revenue, we estimate) as a result of prote
producers cutbacks, and with possible additional volume risk mo
broadly, we have some concern that not only will CPOs co
milling businesses face a difficult YoY comparison to 2008 bu
that it will also face some margin headwinds in North America
BG integrates the business in 2009 (pending shareholder approv
in what we expect to the October/November timeframe).
BG May Prove Better Insulated from 09 Macro Headwinds than Some Peers
As explained below, we see several reasons why BG may prove bettinsulated from Macro headwinds in 2009 than some of its peer
including: 1) implications of geographic diversificati
(particularly BGs strong South American presence), and 2) o
expectation for continued strong profitability in BGs fertiliz
business.
Geographic Diversification: Among grain processors, BG enjoys o
of the most geographically diverse asset networks (see figure
Heading into 2009, we believe the companys exposure to processi
businesses outside of North America will better insulate it fr
several potential macro conditions, including a lower tonnage U
harvest and a potential fed tightening cycle, which could pro
risks for US-based processors.
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Figure 19: BG Oilseed Processing Network by Region
Europe,24%
South
America,
37%
Asia, 3%
NorthAmerica,
36%
Source: Company filings
For starters, a weak US harvest increases the onus on other par
of the world to meet global consumption demands, most notab
South America given its agricultural infrastructure and favorab
growing climate. With 37% of BGs oilseed processing capaci
located in South America, primarily Brazil, we view BG as the bes
positioned oilseed processor to benefit from this shif
Likewise, the companys proposed merger with CPO the #1 mark
share player in South American corn milling further insulat
it, we believe, since CPOs US exposure ($1.0 billion in reven
in 2007) is balanced by its South America exposure ($925 milli
in revenue), where profit margins are already structurally highe
This is not to say that BG wont face an incrementally le
favorable profit environment in its oilseed and/or corn milli
(post-CPO) businesses. In fact, North America houses 36% of i
oilseed processing capacity and the US represents 30% of CPOcorn milling capacity). But, such risks are reasonably we
balanced, in our view, against businesses that could well benef
from a lower tonnage US harvest.
Not merely in the near-term, but also over time we believe th
South America presents a more significant crop expansi
opportunity for agribusiness processors, both via yie
improvements and acreage expansion. Of course, land acquired f
crop production can often take 3+ years to bring up to adequa
production levels. Thus, much of todays crop production growwas set in motion three years ago. For soybeans BGs prima
raw material 2005 acreage was some 65% above 2000 level
Further acreage expansion opportunities exist and as shown bel
by the change in SLC Agricolas expansion plans, we believe th
market is responding to expansionary price signals. Specificall
in April 2008 the company -- one of Brazils largest owners a
operators of farmland had anticipated a mid-teens planted ar
expansion rate in each of the next several years (also reflecti
second-crop opportunities). Since then, this forecast has be
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revised upward a full 10 percentage points, with the company n
anticipating a CAGR in the mid-20% range through 2010. While mu
of this expansion is via acquisition of existing farmland, SL
Agricola highlights greater efficiency (better yields a
increased second crops) as an important part of its value creati
proposition.
Figure 20: SLC Agricola Planted Area
Expansion Plan
As of 4/30/2008
Figure 21: SLC Agricola Planted Area
Expansion Plan
As of 7/31/2008
Source: SLC Agricola Source: SLC Agricola
As such, acreage is only part of the story. Efficiency of t
land is another key component one that stands to benefit BG
two ways: 1) increased raw material for production, and 2) dema
for fertilizer. Currently, Brazilian soybeans yield 2.85 tons p
hectare or roughly -1% less productive than US farmers, thou
we are familiar with some land in Brazil garnering as much as 3.2
tons per hectare when optimized. Perhaps more interesting,
corn yields are 2.7x Brazilian corn yields (9.36 tons per acre o
average versus 3.64). However, we are aware of some Brazili
land garnering corn yields of closer to 9.7 tons per acre wh
optimized and thats before accounting for second-cr
opportunities (October to December planting window and a Janua
to February window).
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Figure 22: Corn Seed Trait Adoption in South America
Source: Monsanto
Figure 23: Oilseed Seed Trait Adoption in South America
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Source: Monsanto
In addition, BGs non-US exposure (including Fertilizer, 35%
normalized EBIT, and roughly two-thirds of its oilseed processi
capacity, an estimated 30% of normalized EBIT) also serves as
hedge against a possible reversal in the weak US Dollar
particularly important should the Fed enter a rate tightenicycle. Under such a scenario, we believe the competitiveness
commodities originating in the US may be at risk. In fact, while
stronger dollar may well alleviate domestic inflation pressure
it could have the opposite effect abroad, where US agricultur
commodities absent a correction would become more expensive
a local currency basis. In our view, under such a scenario, t
purchasing power of importing countries is reduced such that t
aforementioned demand elasticities may become evident in volu
trends. Alternatively, if agricultural commodity prices were
fully correct in response to potential interest rate tighteni(see figure), we believe that too would have consequences f
financial returns of domestic grain processors. Under su
circumstances, those processors with proportionately fewer asse
within the US are better insulated.
Figure 24: Commodity Prices versus US Dollar Trends
250
300
350
400
450
500
550
600
Jan-
05
Apr-
05
Jul-
05
Oct-
05
Jan-
06
Apr-
06
Jul-
06
Oct-
06
Jan-
07
Apr-
07
Jul-
07
Oct-
07
Jan-
08
Apr-
08
CRB
Index
$0.55
$0.60
$0.65
$0.70
$0.75
$0.80
$0.85
$0.90
USD/EUR
CRB Index USD/EURpositive correlation
negatve correlation
Source: FactSet and Lehman Brothers analysis
Should the US dollar strengthen, and therefore weaken t
competitive position of US agricultural commodities globally, BG
South American operations, which account for 37% of its ass
footprint and depend largely on the health of the Brazili
soybean farmer, may benefit. BG has indicated in the past that th
health of the Brazilian soybean farmer may be in jeopardy as
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soybeans approach $11 per bushel. If the dollar were
strengthen against the Brazilian Real, this $11 per bushel ra
would translate to a higher dollar amount relative to the Real
again assuming the negative correction in the underlying commodi
price is not more severe than the inverse correction in the
dollar.
Fertilizer: BG derives an estimated 35% of its normaliz
operating profit from fertilizer, which we believe provides it
partial offset from US crop damage. While the company
fertilizer products are distributed most heavily in South Americ
its pricing is nevertheless tied to global fertilizer prices.
the extent that early season US crop damage encouraged t
reapplication of fertilizer (not entirely clear, at this stag
and/or accelerated development of farmland in South America,
may have buoyed demand for fertilizer on a global basis a
therefore prices, thereby widening margins for producers
fertilizers. While this may create a headwind in 2009 vers
strong 2008 levels, we believe that US crop rotation back to co
(from soybeans) may lend support to high fertilizer prices, sin
corn is a more fertilizer-intensive crop. Also of significanc
we estimate that BG enjoys a $40-$60 per metric ton transportati
advantage versus much of the rest of the fertilizer market
South America, which is import-driven. As biofuel displacement
transportation fuel slows (because biofuel producers are forced
run idle given higher corn and soybean costs), BGs transportati
advantage versus importers may widen further.
Plus, BGs primary profit exposure in fertilizer is to phosphat
where the company is vertically integrated. We believe exposu
to phosphate may provide it some insulation from more aggressi
capacity expansion initiatives in other fertilizer bases.
fact, the required Greenfield expansion period for phosphate ro
is 3-4 years and the cost of Greenfield expansion is $1.5 billio
per million metric tons higher than both potash and nitrogen.
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Figure 25: Fertilizer Greenfield
Expansion (# of Years)
Figure 26: Fertilizer Greenfield
Expansion ($Bn/MMT)
6.0
3.5
3.0
0
1
2
3
4
5
6
7
Potash Phosphate Nitrogen
$1.5
$1.4
$1.0
$-
$0.2
$0.4
$0.6
$0.8
$1.0
$1.2
$1.4
$1.6
Phosphate Potash Nitrogen
Source: Potash Corp presentation (June 2008) Source: Potash Corp presentation (June 2008)
When the phosphate market first began to tighten in 2004, litt
new capacity expansion had been announced. In light
projections for continued solid demand for acreage expansion, thmarket may remain tight over the near-to-intermediate ter
Likewise, the high capital costs of Greenfield expansion
phosphate provide a barrier to entry. As a result, we belie
phosphate margins may be better insulated. Still, as BGs o
capacity expansion initiatives in this market attest, the econom
incentives for expansion are firmly in place. Plus, the tren
line growth in phosphate demand over the past five years has bee
below that of potash (3.8% versus 5.6% for potash). Although
does sell fertilizer blends, it is not vertically integrat
outside of phosphate.
Figure 27: World Potash Projects vs
Demand Growth
Figure 28: New Phosphate Rock Capacity vs
Demand
based on committed projects including POT's Saskatchewan brownfield expansion
Million Tonnes KCI, Cumulative Growth
0
2
4
6
8
10
12
14
16
2008 2009 2010 2011 2012
POT's Saskatchewan Brownfield
Committed Capacity Expansion Projects4% Demand Growth (4.5% '08 projection)
based on committed projects
Million Tonnes Rock, Cumulative Growth
0
5
10
15
20
25
2008 2009 2010 2011 2012
Committed Capacity Expansion Projects
3% Demand Growth (3% '08 projection)
Source: Potash Corp presentation (June 2008) Source: Potash Corp presentation (June 2008)
LT Favorable Bias: Flexibility in Assets, Trading Platform and Balance Sheet
In addition to our expectation that BGs geographic exposure a
business mix should provide some insulation against potenti
macro headwinds, our long-term bias on large cap grain processo
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is decidedly more constructive than our near-to-intermediate ter
For instance, while we anticipate inflation induced dema
destruction on the margin in the near-to-intermediate term,
also expect any associated easing in prices will in short ord
draw any number of buyers competing for agricultural resources
whether ethanol producers, protein processors, food manufacturer
or the like. This same dynamic should also allow for capaciexcesses associated with new construction to be absorbed in a mo
timely fashion than perhaps weve seen in the past. And, beyo
2009, wed also expect the risks from a weak US harvest in 2008
related to unusually high precipitation levels -- and cr
rotation to soybeans to revert (alleviating potential utilizati
pressures on BGs North American assets).
At its most basic level, the worlds need for food and renewab
fuels is growing and only a handful of large, well capitalize
agribusiness players are able to satisfy this demand. Althou
agricultural processing is arguably a commodity business
thriving (and sometimes merely surviving) in this business hing
on: 1) being among the most efficient, lowest cost producers, a
2) having the flexibility to quickly adapt to changing mark
conditions. In our view, to be the most efficient, lowest co
producer requires scale, scale, and more scale. By the sa
token, to adapt to changing market conditions requires having th
right asset footprint in the right place at the right time or,
a minimum, the ability to swing assets (or the functionali
thereof) in response to sophisticated forecasting tools, de
institutionalized knowledge, and cross-organizational glob
information flow.
Altogether, the barriers to entry in this industry are high,
the market is not particularly hospitable to those processors wi
a small asset footprint, less sophisticated trading/informati
systems, or limited access to capital. For this reason, we do n
anticipate a significant threat from new entrants in tradition
agribusiness processing segments, but rather believe the indust
consolidation that has taken place prior to the most recent up
cycle should keep todays well capitalized players in the driver
seat. Even in emerging agricultural businesses, like ethanol,
ultimately expect a round of consolidation to drive out tho
processors less able to operate with scale and flexibility
their assets.
In addition, BG enjoys a trading platform that allows it
capture arbitrage opportunities as they arise and/or mitigate i
exposure to fluctuations in the commodities market thou
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visibility into such activity is generally quite limited and c
complicate earnings forecasts in the near term. We will
listening closely over the course of the CPO integration to gau
whether BG believes it can enhance returns over time in t
acquired business by adopting a different risk management strate
than traditionally employed by CPO.
Furthermore, we do not underestimate the importance of balan
sheet strength and access to capital markets -- not only in troug
periods, but equally important in periods of rising commodi
costs where working capital requirements can become burdensome a
stress liquidity positions. Those processors with strong balan
sheets are arguably advantaged in their ability to capture mark
share, expand capacity, and consolidate distressed asset
Interestingly, on this basis, our math suggests that, if approve
BGs all-stock acquisition of CPO one of the least levered name
in the large cap agribusiness sector would noticeably impro
its liquidity profile. Given the below average leverage profi
of CPO, the BG/CPO combinations pro forma balance sheet a
credit ratios may also enhance BGs ability to secure
additional round of new debt financing. In this sense, aside fr
the strategic rationale for BGs announced acquisition of CPO, w
also view the transaction as a pseudo balance she
recapitalization maneuver and one that very well may serve as
case study for other agribusiness processors in the futur
Separately, wed note that if grain and oilseed prices were to se
recent declines hold, this would likely reduce working capit
needs (although not necessarily a positive for credit metrics ti
to the companys income statement).
Figure 29: BG - Potential Financing Surplus (Before and After CPO Acquisition)
BG (standalone) BG (pro forma for CPO)
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Note: Cash surplus (gap) based on discretionary FCF of $296M and $446M in NT and FY09 respectively, normalized $940M/yr
thereafter
Note: Coverage and Leverage ratios calculated on an 8-quarter rolling basis
*Near Term (NT) implied cash surplus (gap) is net of current cash and ST securities
*ST revolving credit facilities, including BG's $600M CP program, total $1.6bn, with $426M drawn upon as of March 31, 2008
**FY10 onward based on normalized discretionary cash flow
***LT revolving credit facilities total $2.1bn due through 2011, with $760M drawn upon as of March 31, 2008 (and $0 of
CPOs $500M revolver)
****excludes equity units / convertible notes of $690 million after 2018
Source: FactSet, company filings and Lehman Brothers' estimates and analysis
Aside from Co-Product Risk in 09, CPO Addition a LT Positive for BG
Relative to ADM and BG (standalone), Corn Products Internation
(CPO purchased by BG on 6/23/08, pending approvals) operates
considerably more focused network of assets and sells a far le
diversified portfolio of end products. While the form
processors derive scale partly from their product breadth,
would argue that Corn Products derives scale within its business
via its concentration of assets (CPO ranks third in installed co
processing capacity in North America and first in South America
In fact, while BG and ADM each generated more than 10x the revenu
generated by CPO in calendar 2007, they generated only 3.8x an
6.1x the operating profit of CPO, respectively. In other word
CPOs concentration of assets within corn processing and i
selection of end-markets have translated into a sizable marg
differential on a consolidated basis versus its peers, one whi
now stands to benefit BG.
Figure 30: Grain Processor RevenueComparison Figure 31: Grain Processor EBITComparison
$ in millions / multiples are indexed vs. CPO
$3,391
$-
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
CPO BG ADM
11.2x
15.6x
$ in millions / multiples are indexed vs. CPO
$341
$-
$500
$1,000
$1,500
$2,000
$2,500
CPO BG ADM
3.8x
6.1x
Source: Company filings and Lehman Brothers analysis Source: Company filings and Lehman Brothers analysis
This is not to suggest that CPOs model is necessarily superi
(in fact, returns on invested capital for these processors are n
dissimilar; see figure), but rather to highlight that there a
important differences in operating models between CPO and i
grain processing peers that we believe are worth exploring, as
they may have implications for operating performance over the ne
12 months and 2) over the long term, may provide some takeawa
that can be incorporated into BGs operating philosophies.
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Figure 32: Grain Processor ROIC Trend Comparison (2003-
2007)
0%
2%
4%
6%
8%
10%
12%
14%
16%
2003 2004 2005 2006 2007
ADM BG CPO
Source: Company filings and Lehman Brothers analysis
Importantly, certain business models provide greater insulation
supply-push inflation. Several differences exist in CPOs mod
that may insulate it from aforementioned risk factors heading in
2009. Specifically, these differences include: 1) a practice
its North American operations of hedging corn cost exposure up
securing customer supply contracts at fixed prices, 2) a larg
percent of operating profit derived outside of North America, 3)
market leadership advantage in South America with favorab
implications for corn milling operations, and 4) a focus o
traditional processing business, with limited or no dire
exposure to ethanol production or ag services.
For instance, supply-side events tend to be regionalized, su
that grain processors (like those within our coverage univers
who enjoy a fairly well geographically-diversified asset base a
able to offset headwinds in one region with profit tailwinds
another. Similarly, those processors whose portfolios a
concentrated more heavily in higher value-added business line
like CPO, may also be better suited, in our view, to manag
supply-push inflation pressures by commanding pricing powe
Likewise, a portion of CPOs contracts with customers tend to
based on tolling agreements, which effectively shift the risk
grain prices to the customer, while raw material requirements fo
other contracts are hedged at the time the contract is signed
And, given that grain requirements are often hedged but c
products (e.g. corn feed, corn oil, corn meal) are sold closer
the market, processors like CPO have, perversely, be
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beneficiaries from supply-push inflationary pressures, at lea
during the hedged period.
North American Risk Management Practices: In North America, CPO
history has been to lock-in corn costs upon securing custom
supply contracts at fixed prices. With other customers,
sometimes operates under tolling agreements. This spremanagement philosophy, particularly in starch-based product
like high fructose corn syrup, tends to insulate the company
North American operating profits from unfavorable increases
corn costs, like the recent spike brought about by the late sta
to the growing season and flooding in the Midwest. In fact,
discussed previously, this operating philosophy actually enabl
CPO to benefit during a period of rising raw material costs. Th
is because pricing of the raw material (corn) tends to drive pass
through pricing of co-products (corn feed, corn oil, and co
meal). To the extent that CPO is exposed to favorable pricin
but has locked in its raw corn requirements, it allows the compan
to realize incremental profit.
Of course, the converse may also be true in a falling corn co
environment. And, risk management only delays the onset of high
costs, which eventually will be passed through in the form
higher prices on negotiated contracts. We believe the ability
pass through the entirety of the input cost increase hing
largely on whether the cost pressures are supply-push driven
demand-pull driven. Demand-pull driven cost pressures imbue so
degree of leverage with the processors, particularly in
environment characterized by tight processing capacity. On t
other hand, supply-push inflation creates risk of elasticity
demand, particularly where excess processing capacity is in pla
and acts as a limiting factor in pricing power. As we look to t
key end-of-year contract renegotiation period and price setti
for 2009, although capacity currently remains tight, the source
the inflationary pressure has become increasingly supply-pu
driven as a result of a likely weak US harvest an importa
watch point, in our view.
Geographic Diversification: Just 30% of Corn Produc
Internationals revenue was generated in the US in 2007. Whi
not immaterial, the combination of geographic diversification a
spread management policies in North America may provide great
insulation to CPO relative to other processors within our covera
that are more exposed to a likely weak North American harvest.
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Not only is CPO geographically diversified, but the company enjo
a strong leadership position in its South American corn milli
operations, including the largest installed processing capacity
Argentina, Brazil, Chile, Colombia, Peru and Venezuela. In o
view, this leadership position lends support to CPOs abov
average operating margins in this business (15.2% in South Ameri
versus 6.9% in North America since 2003). Also notable, in oview, is that this leadership position has provided somewhat mo
profit stability than in North America (1 standard deviation
operating profit is 75% from the long-term mean in South Ameri
versus 97% in North America) an even more impressive fe
considering that tolling agreements and hedge policies on fix
price contracts are less widely employed in CPOs South Americ
operations. Rather, we believe this is a function of t
companys pass-through pricing capability in the region.
And, as a final note, since the availability of corn in Sou
America has not been impacted directly by the likely lower tonna
US harvest, we believe CPOs asset utilization in the region wi
not suffer. Furthermore, the company may be able to offs
weakness in its US operations by utilizing its non-US assets
take advantage of market share opportunities in other parts of t
world. If the US were to enter down the path toward an intere
rate tightening cycle, we believe this effect would be even mo
pronounced.
A Focus on Traditional Processing Operations: Unlike ADM
exposure to ethanol, trading, and ag services, or BGs exposure
fertilizer, CPO has very little exposure to non-tradition
agricultural processing businesses. While at times some may arg
this limits its opportunity to participate in other, mo
profitable or faster growing markets, we believe this focus o
traditional processing will hold the company in good stead headi
into 2009. Specifically, although fertilizer profitability m
remain intact, wed note that trading profits are near
impossible to forecast, ethanol profitability has been squeezed
the combination of high corn prices and a glut of producti
capacity, and ag services is facing very difficult YoY compariso
along with a set of new headwinds. CPOs focus on tradition
processing operations has had another unintended benefit, in ou
view, for shareholders. It has kept spending on capaci
expansion at more balanced levels, allowing for more cash to b
returned to shareholders. In fact, CPOs diluted share cou
between 2003 and 2007 has increased only 5.6% compared with
27.2% increase for BG. Also during this period, CPO has increas
its dividend on average 15% per year, compared with ADMs 14% an
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BGs 11%. Interestingly, this discipline has also kept CPO
balance sheet in very healthy shape seemingly a selling poin
for BG in its announced acquisition of CPO.
Figure 33: Capital Expenditures vs. Prior Year's PP&E
9%
12%
15%
23%
34%
21% 21%
17%19%
20%
9%
11%13% 13%
14%
0%
5%
10%
15%
20%
25%
30%
35%
40%
2004 2005 2006 2007 2008
ADM BG CPO
Source: Company filings and Lehman Brothers analysis
This is by no means to imply that CPO has neglected grow
opportunities in the business. In fact, the company has a lo
history of innovation, particularly in the sweeteners marke
dating back to its patent on crystalline dextrose in 1923. T
company was also a pioneer in the development of high fructo
corn syrup, which it began producing in 1976. And more recent
(April 2008), CPO unveiled one product in its sweetener pipeli
that we believe may have significant potential in the market --
new low calorie, all natural sweetener, called Enliten, made fro
the Stevia plant. Specifically, CPO announced that it had enter
into a long-term agreement with Morita Kagaku Kogyo Company Lt
of Osaka, Japan. The agreement gave CPO the exclusive license
Moritas patented stevia strain, its manufacturing technology, a
global marketing and distribution rights. Given Cargill
exclusive Stevia-based partnership with Coca Cola (Truvia),
believe that CPO is well positioned to be the supplier of choi
to other beverage manufacturers. And, wed note that t
sweeteners list of applications extends well beyond t
carbonated soft drink market, and includes yogurts, cereals a
snack bars, among other items.
BG Valuation: Points of Insulation Support Premium vs. Grain Peers
Our $97 price target is predicated on a multiple of 14.5x our mid
cycle EPS estimate of $6.69 -- a premium versus both BG
historical mid-cycle multiple of 10.8x and BGs closest peer A
(11.9x). Looking into 2009, we believe BGs premium is warrant
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in light of the aforementioned insulation points provided by t
combination of the companys geographic exposure and business mi
Beyond this, we also believe BGs growth algorithm may
structurally advantaged by its relative exposure to the cr
production expansion potential of South America. In addition,
believe favorable demand-side fundamentals are likely to remain
place ove