May 12, 2008: 4:28 AM EDT
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Commodities giant's high-wire act

Bunge piles on the debt as its farmers struggle and its hedging operation burns up precious cash.

By Roddy Boyd, writer

soybean_harvest.cr.03.jpg
Soybeans are one of the mainstays of Bunge's agribusiness.

(Fortune) -- You might assume the commodities boom has been an unalloyed good for Bunge, a nearly 200-year-old agriculture-industry titan with $38 billion in sales. The company, whose name is pronounced with a hard 'g' (BUNG-ee), is relatively unknown but has long been among the world's largest soybean crushers and a giant producer of fertilizer. Think of it as a sort of Archer Daniels Midland (ADM, Fortune 500) without the ubiquitous public TV advertisements.

At first glance, Bunge appears to be reaping the benefits of record prices for farm staples like wheat, corn and soybeans. Its 2007 earnings soared by 49% to $778 million. And first-quarter results, announced in late April, were even rosier, with net income of $289 million. No surprise then that Bunge (BG) shares have more than doubled over the past two years (and, full disclosure: They have nearly tripled since Fortune recommended the stock in 2004).

But looks can be deceiving. For all its record profits, Bunge is now burning cash at a record pace. The company's cash flow from operations was negative-$411 million last year, even worse than its minus-$289 million the year before. And the cash drain is accelerating: In the first quarter alone, Bunge reported negative-$353 million in operating cash flow. The prime culprits, as we'll see, are huge losses in hedges for soybeans and other commodities.

As a result, Bunge has had to borrow more and more. The company added $1.6 billion in debt during 2007, nearly doubling interest expense to $436 million. Today, what Bunge calls "total financial debt" (total debt minus cash and equivalents) stands at $4.2 billion.

In short, Bunge has become reliant on its revolving credit facilities and access to the capital markets to fund its operations. And as we all know, that's not a happy place to be of late. Bunge learned that firsthand in March, when it pulled a $500 million bond offering, citing "market conditions." Bunge CFO Jacqualyn Fouse says the bonds could have been sold, but at an interest rate the company was unwilling to pay. (That, of course, is precisely the sort of problem that arises when you need to raise cash in a tight market.)

Fouse professes confidence, noting that Bunge has plenty of liquidity. Indeed, the company isn't in any imminent danger of running out of money. On March 31, it disclosed a new $650 million credit facility, and it had $723 million in cash at the end of the first quarter.

But profit that rises even as cash flow falls is a classic sign of looming trouble. Companies that suffer an enduring divergence between the two are disproportionately likely to restate their earnings, says Donn Vickrey, president of independent analysis firm Gradient Analytics. Vickrey's firm has assigned Bunge an earnings quality grade of "F" since 2004. And shareholder advisor Glass, Lewis issued a Yellow Card Alert to its subscribers in February, citing (among other things) two years of negative operating cash flow and possible strains on Bunge's liquidity.

It all adds up to a disturbing series of questions about Bunge's future. Perhaps this is the biggest: If the company is bleeding cash and loading up on debt when commodities are at their peak, what will it do when the cycle ends and commodities prices return to earth?

From Amsterdam to Mato Grosso

Bunge has a lengthy and rich history. Founded as an import-export firm in Amsterdam by Johann P.G. Bunge in 1818, the company specialized in grain. It expanded into Argentina in 1884 and Brazil in 1905 and began trading in the U.S. in 1918. Today Bunge is registered in Bermuda (which is why the company is listed on Fortune's Global 500 rather than on the domestic Fortune 500) but is headquartered in White Plains, N.Y. Despite its age and size - it has more than 25,000 employees spread over 30 different countries - Bunge is relatively new to the capital markets, having gone public only in 2001.

So why is Bunge shedding cash at the same time it is generating rising earnings? The answer begins with the company's fertilizer business and the farmers in the isolated, but fecund soybean cradle known as Mato Grosso, Brazil. Bunge advances fertilizer to many of the growers prior to planting season. In return, they pledge to deliver soybeans after harvest to pay off the debt.

But many of the farmers in Mato Grosso are desperately poor. And with fertilizer prices rising even faster than those for soybeans, a large number aren't keeping up with their obligations to Bunge. So even though revenue at the fertilizer unit jumped 51% to more than $3.9 billion in 2007, some $211 million of the unit's trade accounts receivable - nearly a quarter of the total - are classified as doubtful, meaning the company recognizes it isn't certain to get its money back.

Bunge CFO Fouse says the company is pursuing the delinquent farmers. But recoveries may be limited by the vagaries of the Brazilian legal system. Evicting a defaulting farmer who has pledged land to Bunge may take five to eight years, according to lawyers.

"Recovering the amounts of secured advances in legal action will be a multi-year process," Fouse acknowledges. But she says the company is confident the loans "are well collateralized" and that Bunge expects to gather a substantial portion of what is owed.

The fertilizer division is not the only Bunge unit with collection headaches. In the agribusiness group, which sells and distributes a variety of oilseeds and grains, more than 64% of the almost $379 million in long-term secured advances to suppliers has not been paid, forcing Bunge to go to court to try to collect.

Brazilian farmers and other debtors are only the beginning. The biggest short-term problem has been Bunge's soybean hedges. Precisely because the farmers are paying the company in soybeans - which amounted to a bet on rising soybean prices - Bunge hedged its exposure by selling short soybean futures. That's a standard practice for commodities producers. In normal markets, the strategy works, providing Bunge with protection should the price of soybeans decline.

But with soybean futures shooting up nearly 75% at various points last year, Bunge's hedges have absorbed even more of its precious cash. (As the contracts increase in price, the company is hit with margin calls requiring it to put up more cash to keep the contract open in the hopes prices will drop later.)

The losses from the soybean hedges appear massive, though Bunge's SEC filings provide little illumination. Consider this: Bunge generated $1.15 billion last year in an accounting category it created called "funds from operations." That category doesn't count the hedges. When you include the hedges and calculate cash flow from operations, the result drops by $1.5 billion and results in negative-$411 million in cash flow.

It turns out that the vast majority of that vaporized $1.5 billion was lost in hedges, according to a Bunge spokesman. He notes that a portion of that $1.5 billion loss came from hedging commodities other than soybeans but declines to specify the breakdown.

That negative-$411 million in cash flow doesn't even include the unpaid debts from farmers, which Bunge has yet to take charges for. Should Bunge write down its troubled uncollectible accounts receivable by, say, $500 million, that could wipe out almost half of next year's projected earnings. (Bunge's spokesman pooh-poohs the likelihood of a writeoff. "We analyze these receivables systematically and on a case by case basis," he says. "The secured advances are well collateralized with farmers' land and other assets, and we don't take a write off unless we determine that we can't collect the money or that collateral.")

CFO Fouse, a veteran of senior financial management slots at Alcon, Swiss Air, and Nestle, acknowledges the challenges to Bunge's cash flow. But she argues that a combination of lower, more stable commodity prices and inventory management will turn the tide.

Fouse also says that, if necessary, the company could tap its $3.5 billion pool of readily marketable inventories of soybeans and other commodities. And, she says, Bunge could curtail some planned capital expenditures. The company is due to spend at least $1 billion this year building soybean and fertilizer processing, shipping and storage facilities throughout Brazil. (Some of the areas in which the company operates in places such as Mato Grosso are so undeveloped that it has to construct port facilities and other infrastructure.) Finally, Fouse says equity investors have supported the company's spending - a view readily borne out in the 53% rise in Bunge shares over the past year.

Whose cash is it?

There's another anomaly that raises questions about Bunge's pipeline to cash. As noted, the company reported $723 million in cash on its books at the end of the first quarter. But that figure is misleading. "Of that $723 million, there's about $350 to $400 million that's in Fosfertil," Fouse explained on a conference call announcing the first quarter results.

So what is Fosfertil? It's a Brazil-listed fertilizer company. Bunge owns 41% of it, but has a 54% voting stake and consolidates Fosfertil's earnings on its income statement. (Both companies mine and produce the raw material to sell to fertilizer makers.)

As long as Fosfertil remains flush - and so far there's no reason to suspect it won't - Bunge will be the beneficiary of its cash. Indeed, in March, Fosfertil declared a dividend that paid Bunge $108 million. But should Bunge need cash quickly, it can't tap Fosfertil at will, meaning that half of Bunge's cash is not immediately available.

One reason Bunge's cash flow woes have escaped attention is that the company is not covered by many Wall Street analysts; the ones that do tend to focus on so-called top-line issues like revenues and margins, or trends in the broader commodities market.

Fitch Ratings scores Bunge's debt at BBB, one notch above junk. Senior Director Wesley Moultrie and Director Judi Rossetti see a mixed future. They're optimistic about the company's oilseed processor business - a major Bunge line - but see no shortage of possible storm clouds. "Bunge does not have the significant [product] diversification that others have," says Moultrie, referring to their dependence on the fertilizer and soybean markets.

Moultrie says he would be "concerned if [Bunge] took a write-down of its receivables." Although he declines to elaborate, it at least raises the specter of a ratings drop into junk bond territory, which would, at minimum, raise borrowing costs.

There are still other concerns with Bunge. On March 3, the company disclosed a material accounting weakness, leading to a $7 billion restatement to revenue and cost-of-goods sold. Apparently, $3.5 billion worth of transactions were improperly booked due to an accounting systems change.

To be fair, many corporations have fallen prey to accounting systems upgrade gaffes. In a discussion with Fortune, Fouse was blunt in her assessment, repeatedly calling it "dumb." She says the company has taken steps to remedy the accounting problems.

The other $3.5 billion in restatement is raising a few eyebrows. It resulted from an improper accounting treatment of structured trade finance activities. These multi-billion-dollar transactions are mentioned only once in Bunge's 10-K, in a 53-word footnote stating that "Bunge's agribusiness segment also participates in related financial activities such as trade structured financing to leverage international trade flows and providing risk management services to customers by assisting them with managing price exposure to agricultural commodities."

According to Bunge, this opaque language refers to the company's commodities hedging and other similar activities. Those activities seem only to be increasing: Bunge has formed an investment partnership - a hedge fund - and has raised $80 million from outside investors to begin trading carbon emissions.

Perhaps carbon trading will be a boon and the company will have a better results with its commodities hedging. Bunge's moves may pan out eventually. But the ongoing cash burn suggests investors shouldn't bet on it. To top of page

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