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Stock Analysis & Ideas

Bunge Stock: Profitability is an Illusion

Bunge Ltd. (BG) operates as a holding company that engages in the supply and transportation of agricultural commodities. It operates through the following segments: Agribusiness, Edible Oil Products, Milling Products, Sugar and Bioenergy, and Fertilizer.

We believe investors should avoid this stock because it is fundamentally weak with questionable financials. As a result, we are neutral.

Bunge Doesn’t Have a Competitive Advantage

There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating the earnings power value (EPV).

Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce the business) can be measured using total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.

The calculation is as follows:

EPV = EPV adjusted earnings / WACC
$19,125 million = $1,377 million / 0.072

Since Bunge has a total asset value of $28,724 million, we can say that it does not have a competitive advantage. In other words, assuming no growth for Bunge, it would require $28,724 million of assets to generate $19,125 million in value over time.

The second method is by looking at a company’s gross margins because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.

If an existing company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.

In Bunge’s case, gross margins have been cyclical in the past decade. As a result, its gross margins indicate that a competitive advantage is not present in this regard.

Risk Analysis

To measure risk, we will start off by analyzing the company’s earnings quality. We want to determine if the earnings figures are reliable or if they are being manipulated by the accountants. To do this, we will employ a method known as the Beneish M-Score, which can help us identify if a company is an earnings manipulator.

The interpretation is quite simple. If the M-Score is greater than -1.78, then the company is likely an earnings manipulator. In contrast, if the M-Score is less than -2, then the company is not likely an earnings manipulator. Lastly, a score that is between -1.78 and -2 is a possible manipulator.

Although the interpretation is simple, the calculation is not and requires many steps. The formula for this method is as follows:

M-Score =

-4.84
(+) 0.92 × DSRI
(+) 0.528 × GMI
(+) 0.404 × AQI
(+) 0.892 × SGI
(+) 0.115 × DEPI
(+) -0.172 × SGAI
(+) 4.679 × TATA
(+) -0.327 × LVGI

Where:

DSRI = Days Sales in Receivables Index
DSRI = (Net Receivablest / Salest) / (Net Receivables t-1 / Sales t-1)

GMI = Gross Margin Index
GMI = [(Sales t-1 – COGS t-1) / Sales t-1] / [(Sales t – COGS t) / Sales t]

AQI = Asset Quality Index
AQI = [(Total Assets – Current Assets t – PP&E t) / Total Assets t] / [(Total Assets – Current Assets t-1 – PP&E t-1) / Total Assets t-1]

SGI = Sales Growth Index
SGI = Sales t / Sales t-1

DEPI = Depreciation Index
DEPI = (Depreciation t-1/ (PP&E t-1 + Depreciation t-1)) / (Depreciation t / (PP&E t + Depreciation t))

SGAI = Sales General and Administrative Expenses Index
SGAI = (SG&A Expense t / Sales t) / (SG&A Expense t-1 / Sales t-1)

LVGI = Leverage Index
LVGI = [(Current Liabilities t + Total Long Term Debt t) / Total Assets t] / [(Current Liabilities t-1 + Total Long Term Debt t-1) / Total Assets t-1]

TATA = Total Accruals to Total Assets
TATA = (Income from Continuing Operations t – Cash Flows from Operations t) / Total Assets t

Now that we have defined the formula, we need to gather the data to input into the equations, which you will find in the image below:

Image created by the author

Now that we have the required data, we can carry out the calculations which we have summarized in the image below:

Image created by the author

Therefore, Bunge is an earnings manipulator because it has an M-Score of -0.87. This means that the earnings power value that we calculated earlier is likely to be inflated.

Further Evidence of Possible Manipulation

In the past decade, Bunge has burned through billions of dollars. In fact, the company has only had two years of positive free cash flow in the last 10 years. Indeed, it has not been free cash flow positive since 2014.

However, you wouldn’t be able to tell by looking at an income statement. The company consistently reports positive EBIT and net income figures, giving off the impression that the company is very strong. However, this is an illusion because it is actually just burning cash every year.

The reason for this discrepancy appears to be caused by changes in accounts receivables. Companies tend to recognize revenue before cash is actually received, which gets accounted for as accounts receivables.

Given that the changes in accounts receivables have been the largest contributor to the negative free cash flows, this would suggest that the company is recognizing a lot of revenue that it won’t actually collect.

This argument can be further strengthened by the fact that accounts receivables growth has outpaced revenue growth since 2014 – the last time Bunge was free cash flow positive. Revenue has grown at a CAGR of 0.49% from 2014-21 while accounts receivables have grown at a CAGR of 4.1%. As a result, its earnings are mostly made up of paper profits.

This has caused its cash pile to dwindle from $1.9 billion in 2014 to $650 million in the most recent quarter. This is while long-term debt has increased from $2.9 billion to $4 billion during the same time period.

Wall Street’s Take

Turning to Wall Street, Bunge has a Moderate Buy consensus rating, based on four Buys and three Holds assigned in the past three months. The average Bunge price target of $134.83 implies 23.27% upside potential.

With the stock up 24% year-to-date and with a price target of $134, it appears that analysts and investors are not paying attention to free cash flow, opting to focus on earnings instead.

However, it’s important to ask yourself if you’d want to own 100% of a company that has burned through billions of dollars in the past decade, and that doesn’t have a competitive advantage. If the answer is no, then it wouldn’t make sense to own a piece of it either.

Final Thoughts

Bunge hasn’t been able to generate positive free cash flow since 2014 despite consistently reporting positive EBIT and net income. This, coupled with the Beneish M-Score, lead us to believe that the company is manipulating its earnings.

In addition, even with its large paper profits, the company still doesn’t have a competitive advantage. As a result, we are neutral on the stock because we don’t believe shorting the stock while in an uptrend is a good idea.

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