Description

Adecoagro (AGRO) $6.90

Summary

Adecoagro S.A. (AGRO) is an agricultural company in South America, with operations in Argentina, Brazil and Uruguay. The Company is currently involved in a broad range of businesses, including farming crops and other agricultural products, cattle and dairy operations, sugar, ethanol and energy production and land transformation.

AGRO has established itself as a low-cost operator and has crafted a synergistic ecosystem that provides it with strategic options in the commodity markets it operates in. The Company is halfway through its latest 5-year plan which has positioned the firm to accelerate earnings in the next two years with most of the plan’s capital spending already deployed.

Although the Company has demonstrated its operational abilities and communicated its expectations for EBITDA to grow over 25% from 2018 - 2021, the equity currently trades at a low EV/EBITDA of 5x 2019 and less than 4x 2021 expectations. This valuation is due primarily to its country and industry exposure. I believe that the growth forecast is low risk given management’s track record and their progress to date. Even absent multiple expansion, the stock should appreciate 25%-30% over the next two years, with obviously greater upside with multiple expansion. Furthermore, given AGRO’s position as a low-cost provider and track record, there is reason to believe that the Company can continue to compound capital at attractive rates for an extended period.

Opportunity

AGRO operates in two segments: Sugar, Ethanol & Energy and Farming and Land Development. The Sugar, Ethanol & Energy segment operates in Brazil and is a vertically integrated grower and processor of sugarcane. By controlling the source product and the processing operations, AGRO has the ability to shift production to chase profits. Recently, ethanol has priced at a premium to sugar and AGRO has shifted to have up to 80% of production directed towards ethanol. It has been investing to increase its milling capacity to greater leverage its fixed costs and attain low cost producer status. In addition, it operates in an area where it is not in direct competition with many other operators as is the case in other parts of the country. The waste product is used to generate electricity which is sold into the electric grid which further reduces operating costs.

AGRO’s scale is formidable. The Company farms 168k Hectares of land, operates 3 mills that process 95% of its own sugarcane with a capacity of 14.2MM tons and exports 157MW of electricity. With high fixed costs (90%) the firm has pursued scale which, along with its nimbleness in production, has afforded it an estimated 33% cost advantage in its markets.

The Farming segment operates in Argentina and includes dairy, soybean, corn, wheat, rice, sunflower and cotton. The Company has been focused on developing a low-cost competitive advantage through scale and integration while providing multiple options for value realization in often volatile commodity markets. For example, the dairy business has the capacity to manage 8,300 cows and the potential to double the size over the next few years. Recent acquisitions have given AGRO the option of directing raw milk towards the production of liquid milk for the domestic Argentine market or powdered milk to sell into global markets. As with sugar/ethanol, this optionality protects margin dollars as the Company can shift production towards the most profitable end market.

The planted farming operations produce over 800,000 tons per year, harvested from more than 220,000 acres (65% of which is owned land).

AGRO’s end products are typically sold in US Dollars while its costs are incurred primarily in the local currency. Recent inflation and currency devaluation in Brazil and Argentina has increased margins by reducing local currency denominated costs while not impacting US Dollar denominated revenues.

The Land Transformation business is lumpier than the agricultural businesses but provides an opportunity for AGRO to monetize fully developed farms to redeploy capital into more promising endeavors. Although transactions and cash flows are less predictable, over the last decade, AGRO has monetized over $300MM in land, realizing capital gains of over $200MM. AGRO has routinely realized values 15%-30% over the independent Cushman & Wakefield annual appraisal of their properties. It uses that appraisal for the carrying value of land on its balance sheet.

The five-year plan commenced in 2017 is designed to take EBITDA from $288MM to $454MM in 2021 and is driven by the investment of $355MM in capital. The unlevered IRR on expansion capital is 20%-25%. By the end of 2019, $297MM of the incremental capital will have been deployed and significant expansion of EBITDA will accelerate in 2020-2021.

While the Company has been very clear in communicating this story and the projects are relatively low risk blocking and tackling that management has a proven track record of executing, the market is not giving AGRO credit for this cash flow expansion. I expect that the catalyst for value realization will be not only the delivery of the plan, but also a formal articulation of a plan to return capital to shareholders either via buyback or dividend (currently there is no dividend). The Company has disclosed that they are in active discussions with their board on how to best proceed with returning capital to shareholders.

AGCO currently trades at 7.5x 2019E Adj. EBITDA – Maintenance CapEx of $210MM. Applying that multiple to the 2021E forecast of $300MM yields a share price of $12.66, 83% upside to the current price of $6.90. I believe this is an exceptionally asymmetric reward-to-risk situation given the nature and progress of the five-year plan and management’s track record. In addition, I believe there will be additional upside over time as AGCO has a long runway for compounding capital, a solid balance sheet and an accomplished management team.

Catalyst

Increasing free cash flow in 2020, 2021 and beyond.

Return of capital to shareholders via share repurchases and dividends.