ADM: Alas, Dull Margins

The last few months of 2007 were characteristically capricious for the corn ethanol industry. Gross margins evaporated in October, only to get a wintry boost from higher pump prices. On balance, Archer Daniels Midland (NYSE: ADM  ) got bruised a bit, but there were significant offsetting benefits in its fiscal second quarter.

Revenue was remarkable at $16.5 billion, boosted by the combination of a domestic crop explosion and international supply constraints. Agricultural services were the real standout for the quarter, with operating profit posting a 140% gain over last year. Oilseeds processing was solid, though most of the segment's gains came from an investment in an Asian palm-oil producer. Corn processing faced a cost crunch, with bioproducts (i.e. ethanol) taking a 30% profitability pinch.

A few factors limited pre-tax profit growth to 9%. Most straightforward was the rise in input costs, which ran up just as furiously as revenue. Higher expenses ground gross margin down from 8.3% last year to 5.7%.

Perhaps less intuitive is the huge rise in the expense item labeled "Corporate." This nebulous figure roughly doubled last year's amount, and no, ADM didn't build a new headquarters out of gold bricks. Accounting adjustments have to go somewhere, and in this quarter, there was a doozy of a non-cash inventory charge. I'll save you the treatise on LIFO accounting; suffice to say that it's a tax-efficient practice in an inflationary world.

Since we rang in the New Year, corn has popped to a record high, and crude oil has backed away from the $100 ledge. This does not bode particularly well for ethanol enthusiasts VeraSun Energy (NYSE: VSE  ) and Pacific Ethanol (Nasdaq: PEIX  ) in the near term. This challenging environment is exactly why I continue to believe that ADM is one of the few sufficiently solid investment options in the biofuels field. If you want to get even further removed from the crippling cost of corn, you might also consider railroad plays like Burlington Northern Santa Fe (NYSE: BNI  ) and Greenbrier (NYSE: GBX  ) .


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