Description

BG considers itself to be a leading global agribusiness and food company operating in the farm-to-consumer food chain.  The company states that in their 10-k and other filings.  In addition, they also say that they "believe" they are a world leading oilseed processing company and the largest producer and supplier of fertilizer to famers in South America and a leading seller of vegetable oils worldwide.  I believe that they do engage in those businesses. However, I also believe that this may be a fraud.  This realization hit me on their last conference call as they enjoyed a GAAP earnings beat based on fx gains while their free cash flow loss exceeded $1.7 BILLION dollars.  They have consistently engaged in questionable business practices and their accounting is highly suspect.  None of the sellside analysts can even attempt to explain their accounting.  They sheepishly don't even try.  For that matter, neither can the company.  We have received different answers for the same questions over multiple phone calls with management.  See bullet point #8 below.

As per our discussion a month ago, I have decided to submit this brief "bulletized" thesis of why I think something is really wrong at BG.  Next month we intend to provide a more complete description.  It is interesting to note that on their recent earnings call, they did not provide guidance for 2010 but said that the year should be one that they would "be able to perform well".  The company also stated that specific guidance for them is troubling as their business is tough to predict, especially now.  What I find interesting (and troubling) is that the company did not have any problem providing guidance when it was raising a lot of money a few months ago in order to de-lever its balance sheet.  Guidance that was completely unrealistic mind you.  Note that they took down their 2009 earnings guidance of $4.90 to $5.40 to a new range of $3.10 to $3.50 despite the fact that they provided this guidance in August.  Based on this new guidance which is probably not achievable anyway, the company is quite expensive as its stock is trading at $64 per share and the company has $4.5 billion of net debt on its balance sheet.  Additionally, the company guided that they would be cash flow positive for the year despite starting off the first half generating a cash LOSS of NEGATIVE $2.1 BILLION.  At the time, I was surprised that they the company had the audacity to insist that they would make up that deficit in the back half of the year.  They have never come close to that; however, the analysts bought this story hook, line and sinker. Interestingly, the company clearly backed away from this claim in the most recent quarter.  After all, they got their offering done-mission accomplished!  In any event, there is a lot to discuss with respect to BG.  Here is a brief list of items that provide a good start.  

• They mischaracterized the nature of the use of proceeds of their offering on their conf call. They described the raise proceeds to be used for growth when their prospectus said clearly that proceeds were for debt repayment.

• They mischaracterized the nature of the SEC comments on their inventory. They said that the SEC was looking at inventory practices for the industry which was, without a doubt, not the case.

• Free cash flow for the first 6 months of the year was NEGATIVE 2.1 billion despite gaap earnings.

• GAAP earnings were achieved largely thru currency gains.

• The company employs inventory accounting akin to the financial industry-there are three levels (level 1, 2, & 3) for inventory classification. Level three affords the company the most discretion in valuing inventory. This is important b/c their short term financing lines require certain levels of readily marketable inventory. The inventory consists of soybeans so it is unclear why the discretion is needed. There are currently $700 million of readily marketable inventories listed as Level III assets.

• In her prior job as the CFO of Swiss-Air the CFO of BG was indicted along with other members of management for fraud. She was not convicted however.

• The company makes loan to farmers. Notice that more and more loans have been reclassified to long term from short term. The company is owed several hundred million dollars of past due receivables from farmers and has set a very low reserve on these loans despite their lack of ability to collect. The company also states that they have collateral for these loans but I don't think this has been filed or proven. In fact, they likely do not have collateral. Year over year, the Company continues to recognize interest income on these notes even though a large portion of them are never paid down. In spite of obvious non-payment, the Company has yet to reverse any of the interest income it has booked related to these Notes.

• Their fx and commodity hedging is a morass-absolutely impossible to follow. They cannot explain their program and I have gotten different answers every time I have asked the same questions. They are likely speculating on commodities, similar to Enron.

• In 2007, they mischaracterized $7 billion as revenues inappropriately. They subsequently, amended their financials to eliminate that revenue-whoops! Chump change I suppose. If their auditors can overlook such a material error, how are investors to trust Company claims that the Company's large volumes of Readily Marketable Inventories (currently totaling well over $4 billion) are truly in as liquid a form as the Company claims. Bunge repeatedly states these RMI should be viewed as the equivalent of cash yet has almost $700 million listed as Level III assets.

• In 2007, 6 members of their Peruvian operations went to jail for misappropriating $34 million of repayments of farmer loans. While this is not necessarily the company's wrongdoing, it does suggest a lack of internal controls.

• Bunge was pursuing legal action for collection related to $182mn of the noncurrent secured advances (loans for the 2005 & 2006 crops) as of 12/31/08.One would expect that they have a high probability of going uncollected. However, reserves for uncollectible current and noncurrent have declined to only $37mn, 6% of total advances, and write-offs for the last three years have totaled only $34mn for these loans.How is it that Bunge has been able to get by without writing off long-in-the-tooth unpaid receivables and notes that, most likely, will never be paid by moving Fertilizer Receivables from Current Assets into Long Term on a regular basis?Regarding collateral on secured advances to suppliers and farmers, is it realistic to assume that the Brazilian government would permit Bunge to actually foreclose on such collateral? If such action is unlikely shouldn't a greater allowance be carried.

• There are many other issues-I will, leave you with just one more item: From 1998 to 2008, the company has generated positive Net Income in every single year bar one. In the same time period, the company has generated NEGATIVE FREE CASH FLOW in every year except for two. Collectively, BG has generated cumulative net income of $4.1bn, while burning through $1.4bn of cash during that same period. How can that be???

I just finished reading "the smartest guys in the room" about the Enron debacle.  As I read the book, I was simply shocked at the company's behavior and the inability of the investing public, the auditors, the attorneys and the SEC to discover what were fairly obvious warning sings of wrongdoing.  One striking similarity between Bunge and Enron is that Enron leaned heavily on their trading operations, which were difficult to follow and which they tried to obfuscate.  It seems that a closer look into Bunge's hedging activities for currency and commodities may provide some good clues.  I do not believe that they have explained their activities well to the street and it appears that they are misrepresenting their hedging activities substantially.  Trust me, if you spend time with the CFO, you will most likely walk away thinking that she is not equipped to handle such a massive hedging and trading program that BG employs.

So what would you pay for a company that has demonstrated a complete lack of ability to generate free cash flow during its history?  I wouldn't pay much.  I would certainly not pay $8.8 billion, which is where it trades today.  Recently, the stock has made a bit of a comeback after bogus rumors have circulated about Mosaic taking them out.  To quote my analyst, I will eat my shoe if this happens.  Mosaic does not want to own this mess.  Lastly, in the Citibank presentation today, they said they can grow earnings (GAAP not real cash earnings) by 10-12% percent per year for 3-5 years.  It seems as though this was a stealth and dramatic guide-down from consensus.  If my math is correct, growing earnings 12% from the $3.10 to $3.50 per share will not put them anywhere close to the consensus earnings of approximately $5.70 that is out there for 2010.  And, if they can only produce earnings of between $3-$4 per share next year, my guess is that they will run out of cash during the year, once again. 

Catalyst

1. Analysts do the math and realize they have just guided way below the consensus eps numbers.

2. their cash flows do not improve which will cause a liquidity crisis in 2010.

3. Fertilizer prices remain at currrent or sligthly elevated levels, which will cause a problem for the company.

4. China, slows down their purchases of soy which currrently appears to be akin to "stuffing the channel."

5. They continue to miss earnings and generate negative free cash flows and run out of explanations.