How corn and soy affect these 3 sets of biodiesel stocks

Beans and corn caught my eye, and this time it’s not just because ShopRite has put summer succotash on sale.

Prices for the two major US cash crops are well below recent highs. Corn is down 12% since the end of June. Soybean oil has fallen 25% since mid-May. Meanwhile, the actions of ingredient makers

Archer-Daniels-Midland

(symbol: ADM),

Bunge

(BG), and

Cherished ingredients

(DAR) fell much faster than the market.

This raises questions. What’s next for crop prices? Have these shares reached attractive levels? And is Bunge pronounced like bungee, stretchy cord, or does it rhyme with diving?

Neither: it’s a hard “g” and a long “e”, like overalls, minus the “ar”. And JP Morgan just upgraded the stock from Neutral to Overweight, predicting a 22% rise in one year. It’s even sweeter on Darling, calling for a 39% gain.

Before exposing this case, allow me the briefest of introductions to bean compression. A bushel of soybeans weighs 60 pounds and can be turned into about 48 pounds of protein-rich meal and 11 pounds of oil, plus some waste. The difference in price between the beans and these products is called the spread. Beans and corn like to be planted in rotation with each other.

Grocery shoppers are forgiven for assuming soy plays a minor agricultural role; US demand for tofu (soybean curd) and edamame (immature soybeans served in the pod) is limited. But meat eaters indirectly eat heaps of soybeans, because almost all of the soybean meal goes to feed cattle, pigs and poultry. Most oil, on the other hand, is used to feed people. Think margarine, salad dressing, and “vegetable” oil, as marketers like to call it.

Bunge and Archer Daniels process the soybeans, and in the short term their shares can be swapped with the beans, but in the long term it’s the spread that matters most. It has come down, but could rebound if some market force suddenly pulls demand for soybean meal or oil higher. Margarine, fortunately, is not a producer category. But have you seen the price of diesel fuel?

It turns out that if you combine vegetable oil or animal fat with methanol or ethanol, you can make diesel. I am told there should be sodium hydroxide present and the process is called transesterification. I can’t say more about it without us all putting on safety glasses.

“We think the sudden drop in soybean oil may be transitory,” JPM analyst Thomas Palmer wrote last week. Consider: The US biodiesel industry has about 1.5 billion gallons of annual production today. Projects already announced will add another 1.5 billion in the second half of this year, plus another billion next year and 0.8 billion in 2024. Each new billion gallons of fuel will gobble up an additional eight billion pounds of material raw materials, which is equivalent to 20% of current production of raw materials, including soybean oil and animal fats.

In other words, the bean presses will be very busy. The industry could add 20% to its crushing capacity by 2025, which could help ease soybean meal prices, but oil prices could more than make up the difference.

Bunge dates back to a trading company founded in Amsterdam by Johann Bunge two centuries ago. Today it is based in St. Louis and has large operations in the United States and Brazil. Profits sharply increased grain inflation. In 2019, the company earned $4.58 per share. This year, like last year, it could exceed $12. This is unlikely to last, but stocks are priced pessimistically, at nearly 1.3 times book value, which has always been a bottom. JPM’s Palmer estimates the company will produce “mid-cycle” earnings of $8.50 per share in 2024. The stock is worth just over 10 times that figure.

Chicago-based Archer-Daniels has a lower percentage exposure to soybeans than Bunge, a more stable earnings outlook and a much higher price-to-earnings ratio. JPM rates it at Neutral. I say embarrassingly little about corn here, I’m starting to realize that. Could I make up for it with a few treats made greasy?

Darling Ingredients, based in Irving, Texas, is named after its founder, not the kindness of its business. One of them involves collecting animal fat from slaughterhouses and converting it into salable tallow, a process called rendering. Another is to reuse yellow grease or used cooking oil. Both of these products compete with soybean oil for use in biodiesel.

So Darling is on a pretty high earnings ramp. Two years ago, it cleared $1.78 per share. This year, Wall Street expects it to earn $5.31 per share, and next year, $6.74. The stock recently sold for $59 and is changing.

Now I know what you’re thinking: Darling has all the benefits of fat without the potential headwind of mealtime. Not enough. It also converts carcasses into protein. (If only I had the column space to talk about bone meal.) In fact, Darling just completed the acquisition of a company called Valley Proteins for $1.1 billion. But yeah, it’s less exposed to flour margins than bean squeezers, which is one reason it might have more stock on the upside.

Two last points. First, some or all of JPM’s arguments about these actions could be wrong or, as Palmer puts it, “we could certainly be ahead of that call.” If it doesn’t work, it’s his fault, and if it works, I knew it all along.

Second, there is a serious risk of grain shortages outside the United States, due to Russia’s war in Ukraine. Let’s hope the agricultural giants fill the bellies before the fuel tanks.

Write to Jack Hough at [email protected]

Comments are closed.