Archer Daniels Midland: Ethanol Power

Archer Daniels Midland is one of those anonymous but vital middlemen in the food chain whose products you consume regularly without even knowing it. The Decatur, Ill., company makes the high-fructose corn syrup used in soft drinks, crushes oilseeds to produce edible oils for humans and animal feed for livestock, and mills corn for starch and other products.

But now ADM is making a big play in corn-derived ethanol, a gasoline substitute and additive, and Wall Street is applauding. The share price has tripled in three years, yet Paul Davis, manager of Schwab Core Equity fund, thinks the stock still has room to run.

Schwab employs a highly quantitative method to study 18 financial factors in 3,200 listed companies. Guided by the numbers the computer spits out, Davis has made Archer Daniels (symbol ADM) one of the fund's 20 biggest holdings. Here are some of the factors the computer likes about ADM: expanding free cash flow; a habit of surprising Wall Street with better-than-expected earnings; brokerage upgrades; good management of working capital (short-term assets minus short-term liabilities); improving pricing power; and modest amounts of insider and short-selling.

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What's driving the company now, Davis says, is exploding demand for ethanol because of high energy prices and aggressive lobbying in Washington by ADM. The government is mandating that ethanol be substituted for MTBE, a gasoline additive, for environmental reasons. And as gasoline prices escalate and corn prices remain low, ethanol is becoming a gold mine for ADM, which produces a market-leading 30% of this renewable form of energy. ADM is sold out of ethanol until October. "The demand for ethanol can really only go up," says Davis. ADM is also boosting output of soybean-derived biodiesels, another alternative fuel that's already a large business in Europe.

Analysts, on average, predict that ADM will earn $2.05 a share in the fiscal year that ends July 2007, up 16% from project earnings of $1.77 a share for the June '06 fiscal year. Analysts think earnings will rise 9% a year over the next few years. Using the fiscal '07 forecast, the stock, recently $36, trades at about 17 times earnings.

--Andrew Tanzer