Andersons Offers Ethanol Exposure With Less Risk
By Dan Burrows
July 23, 2007
SETTING ASIDE DEBATES over politics and energy, the reality on the ground is that demand for corn-based ethanol as a gasoline additive has created some seemingly golden opportunities. At least five ethanol pure-plays have gone public in the last two years, but Andersons (ANDE1), a 60-year-old diversified agricultural concern in Maumee, Ohio, might just be the wisest investment in the small-cap space.
Andersons operates five businesses, all of which used to be just good, if stolid, old-economy staples. The company has retail stores, a railcar division and a business that sells fertilizer to golf courses and other lawn-care pros. But the greater part of the company is devoted to selling fertilizer to farmers and storing and merchandising their grain. As a major middleman in the corn business, Andersons suddenly finds itself in the sweet spot of the ethanol explosion, both handling the raw ingredient and making the stuff itself.
"It's the only company that we've been able to find that benefits not only from any upside in ethanol production, but that is also positioned to benefit from the corollary effects of the ethanol boom," says Heather Jones, an analyst with BB&T Capital Markets.
Ethanol demand led farmers to plant 93 million acres of corn this year, according to the Department of Agriculture, enough to cover nearly the entire state of Montana or nation of Japan. That's up 19% from last year and marks the most corn planted since 1944. To make room for all that corn, farmers planted 15% fewer acres of soybeans. Corn is more fertilizer dependent than soybeans and that's already boosting Andersons' plant nutrient business. Furthermore, corn yields about three times as many bushels per acre than soybeans, which bodes well for Andersons' big storage business in the second half of the year.
"There's a massive increase in bushels out there but there hasn't been an increase in grain storage at all," says Jones. "So I think that's going to give the storage guys some increased pricing power."
At the same time, Andersons has pursued a two-pronged, risk-averse approach to producing ethanol itself. The company is carving out an ethanol feed business where it manages ethanol plants, originating the grain, managing the risk and marketing the output. At the same time it has equity stakes in three ethanol plants, two of which are already operational. The third plant should come on line in the first quarter of 2008 and a fourth plant is currently in the works.
"The Andersons is unique in that they were grain merchandisers first," says Tony Sutton, portfolio manager of the Putnam Small Cap Growth fund (PNSAX2), which holds a small stake in the company. "For the most part ethanol stocks are jumping all over the place based on just hype and gut call. Andersons excites me because they already had a good business and have been around a long time with very experienced management."
To be sure, Andersons' stock has seen its share of volatility3, but for the year-to-date it's up more than 12% to $47.56 as of Thursday's close, expanding the market cap to $847 million. That beats the small-cap benchmark Russell 2000 Index by four percentage points. (The stock also pays a 19-cent annual dividend, good for a 0.4% yield.) By comparison, newly minted ethanol pure-plays in the sub-$1-billion-cap space such as Pacific Ethanol (PEIX4), Aventine Renewable Energy (AVR5) and US BioEnergy (USBE6) are down more than 10%, 25% and 35%, respectively, over the same period.
Andersons was actually off about 5% for the year-to-date as of June 20, but then it raised its full-year guidance to a range of $2.80 to $3.05 a share from $2.35 to $2.60, based on better plant nutrient and ethanol production. The forecast sent shares up more than 13% the following trading day. The valuation remains attractive, however, with a forward price/earnings multiple of 14.7 offering a discount of about 20% to peers and 10% to the broader market, according to Thomson Financial. Only two analysts publish long-term growth forecasts, which average 10.5%. For what it's worth, that makes the forward price/earnings-to-growth, or PEG, ratio 1.4, a 20% discount to peers but an 8% premium to the S&P 500. (PEG measures how expensive a stock is relative to its growth prospects.) Forward price/sales, at 1.4, is also attractive.
Shares have continued to climb since the company raised guidance, partly reflecting bullishness ahead of second-quarter earnings to be reported Aug. 2. As a result, the stock is closing in on the Street's average price target of $49.44, which helps explain why analysts are split evenly on whether the stock's a Buy or a Hold.
There's also the risk that Mother Nature won't cooperate with corn farmers' plans. Andersons is a top pick of Piper Jaffray analyst Eric Larson, but his biggest concern over the next several months is the threat of drought in eastern corn-belt states like Ohio, Indiana and Illinois, which make up Andersons' market. Still, he rates shares at Outperform (Buy, essentially), noting that its balanced agricultural portfolio and high degree of risk management should distinguish it from the pure-play ethanol producers.
BB&T's Jones points out that management is legendarily conservative and that the stock price now likely reflects expectations that management will underpromise and overdeliver. Remember that when Andersons raised its outlook in June, that was based on better-than-expected fertilizer and ethanol results; this year's harvest has yet to come in.
"If we get a good harvest, management's guidance doesn't even reflect the more bullish outlook for the grain business, because that's all a second-half occurrence," says Jones, who has a Street-high $53 price target on the shares. "If the harvest is as good as I think it's going to be — and we still do have a few weeks of weather worries to make it through — the stock could easily exceed our target." That would make the implied upside at least 12%, including the dividend, in the next 12 months or so.
That's a pretty nice return for such a risk-averse company. As such, small-cap investors stalking out possibilities among the crop of ethanol stocks might find that Andersons offers an attractive kernel of reward.
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1http://www.smartmoney.com/cfscripts/Director.cfm?searchString=ANDE
2http://www.smartmoney.com/cfscripts/Director.cfm?searchString=PNSAX
3http://www.smartmoney.com/eqsnaps/index.cfm?story=charting&symbol=ANDE
4http://www.smartmoney.com/cfscripts/Director.cfm?searchString=PEIX
5http://www.smartmoney.com/cfscripts/Director.cfm?searchString=AVR
6http://www.smartmoney.com/cfscripts/Director.cfm?searchString=USBE
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