When stock markets are iffy and clients are thinking defensively, consider consumer staples. There are two agricultural companies that stand to benefit from recent industry trends: Illinois-based Archer Daniels Midland Co. and Tate & Lyle PLC of London.

The sector — which includes agriculture and food products, beverages (both alcoholic and otherwise) and tobacco — is enjoying increased profitability, says Charles Burbeck, head of global equities at HSBC Halbis Partners in London. Although revenue in the sector is growing by only 3%-4% a year (slightly slower than the 5% pace of the global economy) earnings are rising by 8%-10% a year — at or above the MSCI world index’s 8% growth. The stronger earnings reflect higher productivity as a result of consolidation and restructuring in the sector, as well as higher prices resulting from the trend toward healthier foods and more frequent but smaller meals often eaten on the go.

The boom in biofuels also represents a huge opportunity for agri-companies. With the dramatic rise in oil prices and the introduction of regulations to include some ethanol in gasoline, demand for biofuels has soared. Both ADM and Tate & Lyle — among the few publicly traded global companies that do initial processing — are involved in biofuels. ADM makes fuel out of corn and oilseed, while Tate & Lyle uses sugar. Both companies are increasing their biofuel capacity.

Both ADM and Tate & Lyle are sound companies, says Burbeck, but they are vulnerable to commodity price swings. This is particularly the case for biofuels, where input costs could be rising while the price of oil is falling.

ADM is the larger of the two companies, with revenue of US$36.6 billion in its fiscal year ended June 30, 2006. The bulk of ADM’s activities involves processing oilseed, corn, cocoa and wheat into ingredients for food, animal feed and alternatives to industrial chemicals. In addition, the company has a large division providing agricultural services, including storage and transportation.

ADM is vertically integrated, with processing plants located near commodity sources and products transported via the company’s merchandising network. The company also has what Standard & Poor’s Corp. ’s rating service calls a “fairly efficient production philosophy.” But, S&P also notes, the agricultural environment continues to be “challenging” and returns on recent investments have been “insufficient.”

Tate & Lyle (formerly Redpath Industries Ltd. in Canada) reported revenue of £3.7 billion, or US$6.7 billion, in its fiscal year ended March 31. It focuses on sugar, wheat and corn milling. It has the advantage, Burbeck says, of a branded product in Splenda, a trademarked sugar substitute of which it is the sole manufacturer. Besides retail sales, Splenda is used as a substitute for aspartame to sweeten diet soft drinks and other diet products. Splenda’s success lies in its natural taste; it is also healthier, Burbeck adds, because it is derived from sugar rather than artificially produced. Tate & Lyle is expanding its Splenda capacity.

Splenda’s market position is not without challenges. Although U.S. rating agency Moody’s Investors Service Inc. considers the risk of product substitution “limited at this time,” S&P expects the company’s current monopoly in the production of sucralose, the generic name for Splenda, to be challenged over the medium term. Moody’s also warns that margins could erode because of a gradual increase in supply.

The new European Union sugar regime will also put pressure on Tate & Lyle’s profitability and sales in Europe. But S&P expects cost-saving initiatives and growth in other businesses to offset this.

The big issue for the share prices of both ADM and Tate & Lyle is that they are no longer unknown or cheap. “Investors have been all over these stocks because of increased demand for food from emerging markets and the new demand for ethanol,” says Burbeck.

In mid-September, ADM was trading at US$38 a share, or 17 times estimated earnings for fiscal 2007; Tate & Lyle’s American Depository Receipt, which equals four ordinary shares, was trading at US$55, or 15 times fiscal 2007 earnings. This is expensive for stocks that don’t have the stable growth of Switzerland-based Nestlé SA or Purchase, N.Y.-based PepsiCo Inc., says Burbeck.

Credit Suisse First Boston Corp. also called ADM expensive in an August report that set a 12-month target price of US$22.50 a share. “It remains to be seen whether output values for corn will continue to grow faster than higher cost inputs,” the report says. It warns of a possible glut in dry distiller grains from corn that could cause a decline in byproducts pricing.

@page_break@Here is a look at the two companies in more detail:

> Archer Daniels Midland. The company, which started in 1902, reported net income of US$1.3 billion in fiscal 2006, vs US$1 billion the year before. Revenue of US$36.6 billion was up from US$35.9 billion in fiscal 2005. Operating cash flow after net change in non-cash working balances was US$1.4 billion, down from US$2.2 billion a year earlier. Long-term debt was US$4.1 billion and shareholders’ equity US$9.8 billion, both as of June 30.

ADM’s 655.7 million common shares outstanding are widely held.Its share price jumped in the first half of the year to more than US$40 from US$25 and has remained around US$40.

Corn processing is its biggest profit centre, accounting for US$877 million (or 43% of company earnings) in fiscal 2006, on sales of US$4.9 billion — or just 13% of revenue. Corn-based bioproducts, mainly ethanol, accounted for US$445 million, or 22% of earnings, in the same period.

ADM pegs potential U.S. demand for ethanol at 10% of gasoline. That translates into 14 billion gallons a year, rising to about 16 billion gallons by 2012. Yet planned additional capacity will double current capacity to just eight billion gallons. ADM is building two plants, which will expand its capacity by 500 million gallons a year by 2008. In addition, it plans to build its first U.S. biodiesel facility with a capacity of 50 million gallons, and add 275 million gallons in capacity to its German biodiesel facility.

ADM also plans to build new plastics and cocoa plants. Together, these and other capital expenditures are expected to cost US$3.1 billion.

Agricultural services, which includes storage and transportation, had sales of US$15.4 billion, representing a 42% share of total company sales in fiscal 2006, and earnings of US$275 million, contributing just 14% to total earnings. Oilseeds had a 30% share of earnings (US$598 million) on a 32% share of sales (US$11.9 billion). Wheat and cocoa contributed US$4.4 billion (12%) to sales and US$159 million (8%) to earnings. Financial operations, which comprise a captive insurance operation and private equity fund investments, accounted for US$151 million (7%) in earnings.

ADM earnings are volatile, however, as demonstrated by the 74% increase in oilseed processing earnings in 2006 on just a 0.5% increase in sales, the 65% gain for corn on an 11% revenue gain, and the 40% drop for cocoa and wheat earnings with sales down only 3%.

S&P expects ADM to continue to be acquisitive in the intermediate term.

> Tate &. Lyle. Founders Henry Tate and Abram Lyle started independently in the sugar business in 1859 and 1865, respectively. The two companies merged in 1921. Tate & Lyle acquired 51% of Montreal-based Redpath Industries in 1959 and the remaining shares in 1989.

The firm has changed its culture over the past three years to a customer-led approach that asks: “What do consumers want and how can we respond to these demands? How can we produce the ingredients that match their requirements?”

Previously, it was a manufacturing-led firm that asked: “How can we produce these ingredients and match them to our customers?”

Tate & Lyle is growing three ways: organically, through small bolt-on acquisitions; through partnerships; and investing 4%-5% of its revenue in research and development. On the ethanol front, it is doubling its U.S. capacity to 200 million gallons by 2009.

The company reported net income, excluding unusual and non-recurring items, of £202 million (US$362 million) in fiscal 2006, up from £146 million the year before. Sales were £3.7 billion, up 11.4% from £3.3 million in fiscal 2005. Operating cash flow after net change in non-cash working balances was £87 million, compared with £191 million. There was £537 million in long-term debt and £172 million in retirement benefit obligations, both as of Mar. 31.

As with ADM, Tate & Lyle’s sales don’t match profitability. Sucralose accounted for 21% of operating earnings in fiscal 2006 but just 4% of sales. Sugar was 47% of sales but only 27% of earnings. Feeds and industrials were 50% of sales and 52% of profit.

There are 489.5 million Tate & Lyle shares outstanding. The ADR price picked up speed in the second half of this year, jumping to about US$55 in mid-September from around US$43 earlier in the year. IE