Bunge Stock: profitability is an illusion

Bunge Ltd (BG) operates as a holding company that deals with the supply and transportation of agricultural products. It operates through the following segments: Agribusiness, Edible Petroleum Products, Flour Products, Sugar & Bioenergy, and Fertilizers.

We believe investors should avoid this stock as it is fundamentally weak with questionable financial data. Accordingly, we are neutral.

Bunge has no competitive advantage

There are several ways to quantify a company’s competitive advantage using only its income statement. The first method is to calculate the Earning Power Value (EPV).

The value of earning power is measured as after-tax adjusted EBIT divided by the weighted average cost of capital, and the value of reproduction (the cost of reproducing the business) can be measured using the total value of the asset. If the earning power value is greater than the reproductive value, then a firm is considered to have a competitive advantage.

The calculation is as follows:

EPV = Adjusted Earnings EPV / WACC
$19,125 million = $1,377 million / 0.072

Given that Bunge has a total asset value of $28,724 million, we can say that it has no competitive advantage. In other words, assuming no growth for Bunge, it would take $28,724 million in assets to generate $19,125 million in value over time.

The second method is to look at a company’s gross margins, as they represent 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 business does not have an advantage, new entrants will gradually take market share, leading to lower gross margins as price wars ensue to stay competitive.

In the case of Bunge, gross margins have been cyclical over the past decade. Therefore, its gross margins indicate that a competitive advantage is not present in this regard.

Risk analysis

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

The interpretation is quite simple. If the M-Score is above -1.78, the company is likely an earnings manipulator. On the other hand, if the M-Score is below -2, the company is probably not an earnings manipulator. Finally, a score between -1.78 and -2 is a possible manipulator.

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

M-score =

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

Or:

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

GMI = gross margin index
GMR = [(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 = (Amortization t-1/ (PP&E t-1 + Amortization t-1)) / (Amortization t / (PP&E t + Amortization t))

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

LVGI = leverage index
IGVG = [(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 accrued charges to total assets
TATA = (Revenue from continuing operations t – Operating cash flow t) / Total assets t

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

Image created by the author

Now that we have the necessary data, we can perform the calculations that we have summarized in the image below:

Image created by the author

Therefore, Bunge is a revenue manipulator as it has an M-score of -0.87. This means that the Earning Capacity value we calculated earlier is likely to be inflated.

Further evidence of possible manipulation

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

However, you wouldn’t be able to tell by looking at an income statement. The company regularly shows positive EBIT and net income figures, which gives the impression that the company is very solid. However, this is an illusion because it is really just burning money every year.

The reason for this discrepancy appears to be caused by changes in accounts receivable. Businesses tend to recognize revenue before cash is actually received, which is recorded as accounts receivable.

Since changes in accounts receivable have been the main contributor to negative free cash flow, this would suggest that the company is recording a lot of revenue that it will not actually collect.

This argument may be further bolstered by the fact that accounts receivable growth has exceeded revenue growth since 2014 – the last time Bunge had positive free cash flow. Revenue grew at a CAGR of 0.49% from 2014 to 2021, while accounts receivable grew at a CAGR of 4.1%. As a result, its income is mostly made up of paper profits.

This caused its cash position to plummet from $1.9 billion in 2014 to $650 million in the most recent quarter. That’s when long-term debt went from $2.9 billion to $4 billion over the same period.

The Taking of Wall Street

As far as Wall Street is concerned, Bunge has a moderate buy consensus rating, based on four buys and three holds assigned over the past three months. Bunge’s average price target of $134.83 implies an upside potential of 23.27%.

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

However, it is important to ask yourself if you would want to own 100% of a company that has spent billions of dollars over the past decade and has no competitive advantage. If the answer is no, it wouldn’t make sense to own part of it either.

Final Thoughts

Bunge has been unable to generate positive free cash flow since 2014 despite consistently positive EBIT and net income. This, coupled with the Beneish M-Score, leads us to believe that the company is manipulating its earnings.

Plus, even with its big profits on paper, the company still doesn’t have a competitive edge. Therefore, we are neutral on the stock as we do not believe that shorting the stock in an uptrend is a good idea.

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