The great commodity pull back of 2011 has started.
Soft agricultural commodities in particular have pulled back a lot lately, generating what appears to be a buying opportunity in the sector. However, I believe it is still too early to dive into a new position in Archer Daniels Midland Co. (NYSE: ADM).
Archer Daniels Midland has experienced a major pull back in the last few weeks. But in my opinion, the stock price will need to show that it has bottomed, and started to trade on expectations of future bullish events before it is again a "Buy."
That means it's time to "Hold" Archer Daniels Midland Co. (NYSE: ADM) (**) – until the current pullback runs its full course and gives investors a safe place to reenter the stock.
Archer Daniels Midland Co. is one of the largest agricultural commodity companies in the world. It is a primary refiner of corn into ethanol in the United States. It also provides contract-milling services, and is involved in private equity investments.
Right now, though, there are four key factors holding back Archer Daniels Midland's stock price:
- Negative cash flow.
- Fallout from the earthquake in Japan.
- A high amount of debt.
- And the stock pays a low dividend.
In the trailing 12 months, ADM has consumed $6.1 billion in cash while only generating $2.1 billion in net income. On the positive side, revenue in the latest quarter increased to $20 billion, which topped analysts' expectations.
The March 11 earthquake in Japan is a big reason for the company's travails, as Japan is the world's largest importer of corn. Because of the disaster, shipments that were destined for Japan have been stranded at sea.
"When you cannot offload ships and you have them sitting out to sea determining when you can offload them, when it comes to valuations, it can make a difference," John Rice, ADM's vice chairman, said on a call with analysts.
Problems like these have caused ADM to take on more debt. And while this has given the company access to capital to grow the business, the U.S. economy is now entering a period of expectations of higher interest rates. This will make it harder for ADM to roll over expiring debt in the future when interest rates are higher. That means ADM, which already has a cash flow problem, will have to burn more money going forward.
Furthermore, with the high debt levels the company is already carrying, it is doubtful ADM will increase its dividend, which at 2% is already on the paltry side.
Indeed, cash flow is the core consideration when I look at Archer Daniels Midland. If the price of corn goes back up and interest rates remain low or drop even further, then it's time to load up. But if commodity prices stagnate or drop and interest rates increase, ADM stock will go from bad to worse.
Archer Daniels Midland stock closed flat on Friday at $31.26 a share. That's right in the middle of its 52-week range of $24.22 and $38.02.
ADM has a very liquid options market, so it offers an interesting stock to write naked puts on.
The September 2011 puts (ADM110917P00029000) with a strike of $29 per share are currently paying over $1.00 at the bid. If an investor wrote one of these puts for every 100 shares they ultimately wanted, they could build a synthetic entry of $28 if the stock price pulls back enough to cause the investor to have the shares put onto them. This gives someone a 10%-plus comfort zone. If the stock bottoms during the summer above $29 per share, you would keep the cash per contract for providing the insurance.
Archer Daniels Midland Company is a "Hold" until commodities stabilize.
(**) Special Note of Disclosure: Jack Barnes has no interest in Archer Daniels Midlands Co. (NYSE: ADM).
[About the Writer: Columnist Jack Barnes started his career at Franklin Templeton in 1997. He started out in the company's fund-information department – just as the Asian contagion infected the Asian tiger countries.
Barnes launched his own shop, RIA, in 2003, just as the second Gulf War was breaking out. In early 2006, after logging a one-year return of nearly 83%, Forbes named Barnes the top stock picker in its "Armchair Investors Who Beat the Pros" competition. His two audited hedge funds generated double-digit returns in 2008.
Barnes retired to the beach in the summer of 2009, and continues to write from there. He's now the author of the popular blog, "Confessions of a Macro Contrarian," and his "Buy, Sell or Hold" column appears in Money Morning on Mondays. In his BSH column last week, Barnes analyzed Silver Wheaton Corp. (NYSE: SLW).
News and Related Story Links:
- Money Morning News Archive:
Previous "Buy, Sell or Hold" Features.
Confessions of a Macro Contrarian.
- Money Morning:
Global Commodity Prices: Soaring Worldwide Population Growth and a Can't-Miss Profit Play
- Money Morning:
Deere & Co. (NYSE: DE) Reaps Benefit From Rising Commodity Prices