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Oct 2 2013 Stock And CMP – Adecoagro S.A. (AGRO) currently trades at $7.61 Investment Summary Adecoagro is an excellent farmland play with a meaningful country risk related to Argentina. Current valuations are however compelling enough to consider the stock with a long-term investment horizon. Company Overview Adecoagro is a South American agricultural company and owns over 275 thousand hectares of farmland and several industrial facilities spread across the regions of Argentina, Brazil and Uruguay. The company produces over 1.2 million tons of agricultural products including corn, wheat, soybeans, rice, dairy products, sugar, ethanol and electricity, among others. For 1H13, Adecoagro generated $291 million in sales and $70 million in EBITDA with a robust operating cash flow of $38.2 million. The Bullish Case The Cushman & Wakefield appraisal and valuation of the farmland property underscores the case of undervaluation and stock upside potential. As of September 2012, the market value of the farmland in Argentina and Uruguay was estimated at $800 million. The same appraisal, values the Brazilian farmland at $137 million. Three recent farmland sale transactions prove that the farmland valuation given above is relatively conservative. On September 2013, Adecoagro entered into a sale agreement to sell the San Martin farm for a total price of $8 million. This represents a 15% premium over the Cushman & Wakefield land appraisal value. In December 2012, Adecoagro completed the stake sale of Santa Regina at an 11% premium over the Cushman & Wakefield land appraisal value. Also, Lagoa do Oeste and Mimoso farms in Brazil were sold at a 7% premium over the Cushman & Wakefield appraised value with the transaction generating $20.8 million of cash proceeds. (Source: Slide 5 of 2Q13 presentation). One can therefore safely assume that the current land valuation would be at a 15-20% premium over the appraised value considering the fact that the appraisal was done in September 2012. A comparison of the land valuation with the current market capitalization is presented below. (click to enlarge) A premium of just 20-40% over the land valuation for a going concern is attractive. For the first six months of 2013, the business has generated a positive operating cash flow of $38.2 million. Also, investments of $126 million for the same period indicate an aggressive growth strategy, which should translate into higher income growth and cash flow growth in the foreseeable future. Therefore, just from the current farmland holding perspective and its capability to generate robust cash flows, the valuations look attractive. The transactions, which have been at a premium over the indicative valuation by Cushman & Wakefield, also point to the fact that Adecoagro has the financial flexibility through farmland sale besides the regular fund raising activities. From a valuation perspective and especially from a cash flow perspective, it is encouraging to witness a steady improvement in the company’s earnings quality. As the chart below shows, the company’s EBITDA cash conversion has increased from 38% in FY11 to 54% in the first half of 2013. This is positive for a high growth company, which needs significant funds for expansion. (click to enlarge) Coming to the factors that will keep the revenue, EBITDA and cash flow growth robust, the company’s sugarcane and ethanol business have witnessed robust growth backed by significant investments in the segments. For the first half of 2013, the company net sales from the sugar, ethanol and energy segment increased by 24% to $117.7 million and the EBITDA increased by 364% to $40.7 million. Growth in the segment will continue and the segment will be one of the key stock price drivers for Adecoagro besides the rich farmland valuation. In particular, the company’s third sugar and ethanol mill in Brazil, named Ivinhema, will drive growth as this will enable Adecoagro position itself as one of the lowest cost producers of sugar, ethanol and energy from sugarcane in Brazil. Adecoagro has completed phase one of the Ivinhema mill with a crushing capacity of 2 million tons. Phase two will add another 2 million tons by 2015 and phase three will increase the total crushing capacity to 6.3 million tons by 2017. To put things into perspective, 2 million tons of annual crushing capacity at full capacity utilization would potentially imply revenue of $120 million and an EBITDA of $40 million considering the 1H2013 EBITDA margin of 30% for the sugar, ethanol and energy business. Therefore, the upside potential is significant in terms of revenue considering higher utilization of the current capacity. From a valuation perspective, Adecoagro currently trades at 7.4 times trailing twelve month EV to EBITDA multiple. It is however more important to consider the forward valuation and the current stock price with respect to forward valuations. If Adecoagro maintains the EBITDA growth rate clocked in the first half of 2013 (highly likely on seasonal factors and increased crushing capacity), the EBITDA for FY13 would be nearly $200. Further, if we consider the EBITDA growth to be somewhere close to the earnings growth estimates for 2014, the expected EBITDA for 2014 would be $280 million considering a 40% EBITDA growth. This would translate into an EV to EBITDA multiple of 4.8 for 2014. Even on the PE valuation front, the expected earnings growth suggests a FY14 PE of 10.4, which is attractive for an agriculture sector company. The primary reason for relatively depressed valuation is the company’s exposure to Argentina, which is subject to significant country risk. However, I believe that valuations will start adjusting on the upside going forward as the company generates a significant chunk of its revenue from Brazil. The constant sale of land at premium valuations also provides the necessary cash flow for investment in the Brazilian business. In order to boost investor confidence and underscore the management’s faith in the business, Adecoagro announced (September 23, 2013) a share repurchase program amounting to 5% of the company’s outstanding shares. The broad timeline for the repurchase is from September 24, 2013, with an initial horizon of 12-months. The repurchase serves two purposes – It positively impacts the stock price and it shows the confidence of the management in the company and the management’s focus on creating shareholder value. According to Mariano Bosch, the CEO of Adecoagro – We are focused on generating attractive returns in each of our businesses. Our consistent ability to sell developed farmland at premiums over the Cushman & Wakefield independent appraisal has enhanced our financial position and reconfirmed the value of our assets. The approval of the repurchase program reflects the Board of Directors’ and Management’s commitment to continue delivering increased value to our shareholders. The Risk Factors The country risk related to Argentina still exists. However, as mentioned above, the risk is diminishing with growing revenue share from Brazil. However, the company’s farmland value in Argentina and Uruguay was at $800 million as of December 2012. Therefore, the asset risk can’t be ignored completely. Another risk factor is the current valuation of farmland. While this is more of the concern in the United States, farmland prices have increased globally. If prices do enter in a bubble territory and decline, the company’s valuation would adjust to the downside. In my opinion, this scenario is unlikely in the foreseeable future as global food demand keeps farmland prices steady. An erratic weather condition is another risk factor in the farmland industry. This factor needs to be discounted in current times when global warming and its impact on the weather is a big concern. Conclusion Despite the risk factors, there are enough positive triggers for Adecoagro and the next few years can be fruitful for the company and investors as the sugarcane and ethanol business drives the company’s EBITDA higher. Investors can consider exposure to the stock with a long-term time horizon. However, there could be enough positive action in the stock over the next 1-2 years and the prices could surprise on the upside. Continue reading →