Description

 Executive Summary

Headquartered in Maumee, Ohio, The Andersons, Inc. (“ANDE”) is an agriculture company primarily engaged in the businesses of operating grain elevators, producing ethanol, plant nutrients (fertilizers), and leasing, buying/selling, and repair of railcars. Due to the volatility of commodity prices and harvest volumes, and unfavorable supply/demand dynamics in some of the company’s key markets, the stock is currently at a 52-week low. The stock has declined 18% over the past month and is down 10% over the past 6 months. We believe that ANDE’s current stock price presents an attractive entry point to invest in a quality company near a cyclical trough but exposed to positive long term dynamics. Due to the company’s several distinct segments, ANDE is underfollowed by both investors and the sell side, and the intersegment synergies are not well understood. Moreover, the company has hidden assets (as described below), to which neither we (in our conservative assumptions) or analysts ascribe value – and which also helps protect the downside of an invesment. We believe management has been working to simplify the businesses and improve the company’s earnings power. Key potential upside catalysts include continued earnings growth from 2015-16 troughs, a simplification of the business, and increased sell side coverage, which could cause the stock to trade closer to some of its peers. Our 3.5 year target price is $52, representing 70% upside to today’s prices and an IRR of 17%, inclusive of dividends (currently $0.64/yr paid quarterly).

Company Overview

ANDE is a diversified agriculture company founded in Maumee, Ohio in 1947 by the Anderson family. The family is still involved, with Michael Anderson serving as Chairman and Daniel Anderson as a senior executive in operations.  Together, Michael, Daniel and Gerard Anderson own over 1.2m shares. The company went public in 1996, and today operates primarily in the Eastern Corn Belt through the following segments:

·         Grain: Primarily operates grain elevators – earning a spread on grain (corn, soybean, and wheat) put through the elevator as well as storage fees. The company also engages in grain marketing, risk management and corn origination services for its customers.

·         Ethanol: The company has a 85%, 55%, 50%, and 34% ownership in four ethanol plants, located in Iowa, Indiana, Michigan, and Ohio, with combined capacity of 330 million gallons of ethanol. The company runs the day-to-day operations of all plants and receives a fixed fee, and supplies corn from the Grain group to all four plants.

·         Plant Nutrient: Manufactures and sells agricultural and related plant nutrients, focusing on specialty fertilizers. ANDE also sells corncob-based products and professional turf care products.

·         Rail: Leases, repairs, and sells various railcars, barges, and locomotives used for the transportation of agriculture. The company currently has a fleet of over 23 thousand railcars with an average utilization of 86% as of Q3 2017.

The company has LTM revenues of $3.8bn and Adj. EBITDA of $153mm. As of FY2016, ANDE has 2,176 full time and 822 part time and seasonal employees.

Management: The company’s CEO is Patrick Bowe, who has been CEO since 2015 and previously an executive at Cargill. Mr. Bowe has 35 years of experience in the agricultural sector and was hired as an experienced external executive to turn around the company’s operations. The company’s CFO is John Granato, who has been CFO since 2012 and previously has experience both in corporate finance and private equity and banking. Management is incentivized to generate pre-tax income, EPS, and total shareholder return. We believe current management has taken positive steps to increase the company’s earnings power amidst difficult market conditions.  For example, the company recently exited underperforming assets in Iowa and Florida, consolidated Cob operations to optimize performance, and exited retail.

Investment Thesis

·         Attractive Entry Point: ANDE’s stock is at a 52-week low primarily due to negative sentiment around supply-demand dynamics in some of the company’s markets, as well as persistent depressed earnings. At current levels, the company is trading at an EV/2017E EBITDA of 8.8x (vs comps at 11x), and an EV/2017E EBITDA-Capex of 15x (vs comps at 16.5x). At our 2017E adjusted EPS of $1.46, the company is trading at 21x vs. a historical average of 20x-30x and current comps at 20x – admittedly a slight discount.  However, we believe the company’s earnings have troughed and earnings should substantially improve from current lows.  When looking out three years instead, to 2020E, we model ANDE generating nearly $3.00 of EPS and over $230m of EBITDA.

·         Complex, Underfollowed Business: The company has four segments that somewhat complement each other but are nonetheless distinct, and the company does not neatly fit into a single industry vertical. This, combined with its relatively small market capitalization, results in the company being underfollowed, covered by only a few sell-side analysts. Furthermore, each of ANDE’s segments has its own distinct business model and market dynamics, and there are also hidden assets on the balance sheet (NOL, equity investments). We note that management does appear to be addressing this by simplifying the business, with the recent announced exit of the retail division as well as the wholesale (commodity) fertilizer segment.

·         Positive Long Term Dynamics: ANDE’s businesses are levered towards positive long term trends, such as a growing population, an expanding middle class, and an increased protein intensity in diets. The company represents an essential component of the US and world’s food manufacturing process and has maintained longstanding relationships with local farmers and growers. Ethanol has emerged as one of the world’s most economical and cleanest sources of fuel, and enjoys growing demand and regulatory tailwinds.

·         Complementary Segments with Natural Synergies and Offsetting Cyclical Effects: The company’s segments naturally complement each other. For example, the Ethanol segment sources grain directly from the Grain segment. The Ethanol segment is also a customer of the Rail segment. The Plant Nutrition segment leverages existing grower relationships cultivated from the Grain segment. The Rail business grew out of servicing Grain division customers. Each of the company’s segments is cyclical in nature, but taken together, they can offset each other’s cyclicality. For example, the grain and ethanol segments are expected to rebound, offsetting the fertilizer segment which is expected to remain weak.

·         Potentially Misunderstood Business Model: A cursory analysis of the company’s financials would reveal high commodity price exposure, low margins, and relatively high capital intensity, which may not be attractive to prospective investors. However, the company operates grain elevators and doesn’t have direct exposure to grain commodity prices (although there are various second order exposures to grain prices). Given the “pass-through” nature of the company’s services, margins based on revenues are also less meaningful for a large percentage of the company’s revenues, and earnings relative to gross profits may be more indicative of the company’s earnings power. The company’s capex is high, but a large component is attributed to the Rail divisions’ business of buying and selling railcars. Excluding this, capex is reasonable and the company can generate a meaningful amount of cash flow.

·         Downside Protection / Margin of Safety: As one of the major agricultural companies in the Eastern Corn Belt, ANDE owns a portfolio of strategically located assets and benefits from deep farmer relationships, providing a moat around its business and downside protection for investors. The company has $800mm BV of assets and $200mm of equity method investments, consisting of storage capacity of 150mm bushels of grain, partial ownership of four ethanol plants, various other distribution and storage facilities, and a fleet of over 23k railcars. Combined with NWC of $200mm and cash of $70mm, this provides considerable asset coverage for the company’s current $1.1bn TEV. Furthermore, the company has ample liquidity, allowing it to withstand many years of earnings pressure from weak commodity prices. In an extreme downside case where gross margins collapse to 5% in each of the next five years (lower than any year in the past 10 years), and grain and plant nutrient revenues continue to decline 5% annually, we estimate that the company would burn $60-$70mm of cash annually, vs. its current cash balance of $70mm and $720mm available on its revolver.

Investment Risks

·         Short-Term End Market Volatility: The company operates in very volatile agricultural markets, where commodity prices can swing significantly based on production volumes / yields, demand, weather patterns, and financial trading levels. Although the grain business is largely pass-through and spread based, and the company hedges out futures price risk, the company’s customer transaction volumes are dependent on pricing. Furthermore, the company uses corn and natural gas as inputs for ethanol, and ethanol pricing itself is dependent on gasoline and oil prices. The Plant Nutrient business uses potash, phosphate, and nitrogen as inputs. Volatility in the prices of any of these commodities could cause significant short term earnings unpredictability.

·         Potential Earnings Pressure from Oversupplied End Markets: There has been an oversupply in the grain markets in the past few years. Although this has shown signs of reversing, the specialty fertilizer market remains pressured as farmers have not been incentivized to improve grain yields using fertilizers. The company expects the margins for the plant nutrient segment to remain pressured in the near to medium term. Ethanol margins have also been soft due to elevated production and inventories, although that is expected to improve over the next year.

·         Competition: ANDE competes with several large agricultural companies such as ADM, Cargill, and Agrium in some of its businesses. The company is not as well capitalized or have as much liquidity as some of its larger competitors. However, the company is more focused on specific geographies and products, and has better relationships with local farmers and buyers within its markets.

Financial Overview & Projections

We have assumed a rebound in the grains segment, continued strong performance in the ethanol segment, and near-term pressure in the plant nutrient segment that eventually dissipates. We also assuaassaasdfasdfasdfsadfsadfsadfdsafasdfasdfasdfasdfasdfITDA-Capex of $151mm, and adjusted net income of $84mm, as well as conservatve forward multiples of 8x EBITDA, 12x EBITDA-Capex, and 15x P/E (a discount to comp forward multiples), we reach a blended 3.5 year target price in the low-to-mid’$50s, using equal weights for each valuation methodology.

Catalyst

Rebound in cyclical dynamics

Continued cost cutting

M&A

Increased coverage