How Corn and Soybeans Affect These 3 Biodiesel Stock Plays

That raises questions. What’s next for crop prices? Have these stocks reached attractive levels? And is Bunge pronounced like bungee, the stretchy cord, or does it rhyme with plunge?

Neither: It’s a hard “g” and long “e”, like dungaree, minus the “ar”. And J.P. Morgan just upgraded the shares to Overweight from Neutral, predicting 22% upside in a year. It’s even more sweet on Darling, calling for a 39% gain.

Before I lay out that case, permit me the briefest of introductions to bean-squeezing. A bushel of soybeans weighs 60 pounds and can be turned into about 48 pounds of high-protein meal and 11 pounds of oil, plus a bit of waste. The difference in price between the beans and these products is called the crush spread. Beans and corn like being planted in rotation with each other.

Grocery shoppers are forgiven for assuming that soybeans play a minor agricultural role; there is only so much U.S. demand for tofu (soybean curd) and edamame (immature soybeans served in the pod). But meat eaters go through piles of soybeans indirectly, because nearly all soybean meal goes to feed cattle, pigs, and poultry. Most of the oil, on the other hand, is used to feed people. Think margarine, salad dressing, and “vegetable” oil, as marketers like to call it.

Bunge and Archer Daniels process soybeans, and in the short term, their shares can trade with the beans, but long term, it’s the crush spread that matters more. That has shrunk, but it could reflate if some market force suddenly pulls demand for soybean meal or oil higher. Margarine, blessedly, is not a category grower. But have you seen the price of diesel fuel?

It turns out that if you combine vegetable oil or animal fat with methanol or ethanol, you can make diesel. I’m told that there should be some sodium hydroxide present, and that the process is called transesterification. I can’t share more on the matter without all of us putting on safety goggles.

“We think the sudden dip in soybean oil could be transient,” wrote JPM analyst Thomas Palmer this past week. Consider: The U.S. biodiesel industry has about 1.5 billion gallons of annual output today. Already announced projects will add another 1.5 billion during the second half of this year, plus one billion next year and 0.8 billion in 2024. Each new billion gallons of fuel will gobble up eight billion more pounds of feedstock, which is equal to 20% of current feedstock production, including soybean oil and animal fat.

In other words, bean squeezers will be kept plenty busy. The industry could add 20% to crushing capacity by 2025, which could help loosen soybean meal prices, but oil prices could more than make up the difference.

Bunge dates back to a trading concern founded in Amsterdam by Johann Bunge two centuries ago. Today, it’s based in St. Louis and has big operations in the U.S. and Brazil. Profits have ridden grain inflation sharply higher. In 2019, the company earned $4.58 a share. This year, like last year, it could top $12. That’s unlikely to last, but shares are pessimistically priced, at close to 1.3 times book value, which has historically been a trough. JPM’s Palmer reckons the company will produce “midcycle” earnings of $8.50 a share in 2024. The stock goes for just over 10 times that number.

Archer-Daniels, based in Chicago, has lower percentage exposure to soybeans than Bunge, a steadier earnings outlook, and a much higher price/earnings ratio. JPM rates it at Neutral. I’m saying embarrassingly little about corn here, I’m starting to realize. Could I make up for it with some rendered-fat tidbits?

Irving, Texas–based Darling Ingredients is named for its founder, not the cuteness of its pursuits. One of them is collecting animal fat from slaughterhouses and converting it into sellable tallow, a process called rendering. Another is repurposing yellow grease, or used cooking oil. Both of these products compete with soybean oil for use in biodiesel.

So Darling is on quite the earnings ramp. Two years ago, it cleared $1.78 a share. This year, it is expected by Wall Street to earn $5.31 a share, and next year, $6.74. The stock recently sold for $59 and change.

Now, I know what you’re thinking: Darling has all the upside from fat without the potential headwind from meal. Not quite. It also renders carcasses into proteins. (If only I had the column space to dish about bone meal.) In fact, Darling just completed an acquisition of a company called Valley Proteins for $1.1 billion. But yes, it has less exposure to meal margins than do the bean squeezers, which is one reason that it might have more stock upside.

Two last points. First, any or all of JPM’s case on these shares could be wrong, or, as Palmer puts it, “We could admittedly be early on this call.” If it doesn’t work out, it’s his fault, and if it does, I knew it all along.

Second, there is a serious risk of grain shortages outside the U.S., owing to Russia’s war in Ukraine. Here’s hoping ag giants fill bellies before fuel tanks.

Write to Jack Hough at [email protected]. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.