Good morning, and welcome to the Archer-Daniels-Midland Company third quarter 2017 earnings conference call. All lines have been placed on a listen-only mode to prevent background noise. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's call, Mark Schweitzer, Vice President, Investor Relations for Archer-Daniels-Midland Company. Mr. Schweitzer, you may begin.
Thank you, Jack. Good morning, and welcome to ADM's third quarter earnings webcast. Starting tomorrow, a replay of today's webcast will be available at adm.com. For those following this presentation, please turn to slide two, the company's safe harbor statement, which says that some of our comments constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements are based on many assumptions and factors that are subject to risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation, you should carefully review the assumptions and factors in our SEC reports.
To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today's webcast, our Chairman and Chief Executive Officer, Juan Luciano, will provide an overview of the quarter. Our Chief Financial Officer, Ray Young, will review financial highlights and corporate results. Juan will review the drivers of our performance in the quarter, provide an update, and discuss our forward look. Finally, they will take your questions. Please turn to slide three. I will now turn the call over to Juan.
Thank you, Mark. Good morning, everyone. Thank you all for joining us today. This morning, we reported third-quarter adjusted earnings per share of $0.45. Our adjusted segment operating profit was $541 million, down 17% from the year ago period. Although we created value in a difficult environment this quarter, our results were below our expectations. The operating environment in the third quarter was more challenging than we had anticipated even three months ago. Ag Services was impacted more than expected by the lack of competitiveness of U.S. corn and soybeans in global markets. In Oilseeds, global crush margins were even more compressed than our outlook last quarter, and we continued to experience tight origination margins in South America.
Through the quarter, we took several actions to be even more competitive in the future, including restructuring our global workforce, reconfiguring the Peoria ethanol complex, working to complete several operational startups, driving additional asset monetizations, and further reducing costs through our Project Readiness initiative. Some of these actions have only begun to take hold in the third quarter. As we move through the fourth quarter, we are starting to transition from the period of costs and investments in acquisitions, new innovation centers, and new facilities to a period of lower capital spending and increasing benefits from these investments. Looking at the external environment, we are starting to see the possible green shoots of recovery in certain areas of our business. However, we are not counting on a significant change in conditions for 2018.
We are continuing to drive operational efficiencies and asset monetizations that are lowering our cost of doing business and increasing our cash flow. In fact, we are taking additional actions adjusting capital allocation among our businesses at an overall reduced capital spending level in 2018, which I will talk about in more detail later in the call. I will turn the call over to Ray.
Okay. Thanks, Juan. Good morning, everyone. Slide four provides some financial highlights for the quarter. Adjusted EPS for the quarter was $0.45, down from the $0.59 in the prior year-ago quarter. Excluding specified items, adjusted segment operating profit was $541 million, down $109 million from the year-ago quarter. The effective tax rate for the third quarter was 13%, compared to our forecasted annual tax rate of approximately 28%, due primarily to the effect of certain favorable discrete items, including return to provision and a favorable outcome of a tax position related to an acquisition, partially offset by changes in the forecasted geographic mix of pre-tax earnings and shift to higher tax jurisdictions.
Our trailing four-quarter average ROIC of 6.4% is 60 basis points higher than the same period last year and 40 basis points above our 2017 annual WACC of 6.0%, thus generating positive EVA of $98 million on a four-quarter trailing average basis. On Chart 18 in the appendix, you can see the reconciliation of a reported quarterly earnings of $0.34 per share to the adjusted earnings of $0.45 per share. For this quarter, we had $0.12 per share charge related to asset impairments and restructuring activities, and a $0.02 per share net gain on the sales of assets and businesses, and a $0.01 per share loss on debt extinguishment.
Slide five provides an operating profit summary and the components for our corporate line. Before Juan Luciano discusses the operating results, I'd like to highlight some of the corporate items affecting our quarterly results. In the corporate lines, net interest expense was relatively flat at $72 million versus last year. Looking ahead, we're continuing to project net interest expense of approximately $320 million for the full year 2017, consistent with what we indicated at the beginning of the year. Unallocated corporate costs of $109 million were up slightly versus the prior year and below our $140 million per quarter guidance for fiscal year 2017 on lower spending for special projects and reduced employment and benefit costs. Minority interest and other charges increased by $9 million. Turning to our cash flow statements for the first nine months on Slide six.
We generate $1.6 billion from operations before working capital changes, similar to the prior year. We had favorable changes in the working capital of a bit over $500 million. Total capital spending was about $700 million. Our current expectation for fiscal year 2017 is capital spending of approximately $1 billion. Acquisitions to date of $187 million were primarily related to Crosswind Industries, a pet treat manufacturer, and Chamtor, a French producer of wheat-based sweeteners and starches. We spent almost $700 million to repurchase shares, and including dividends, we returned $1.2 billion of capital to shareholders in the first nine months. Our average share count for the quarter was 569 million diluted shares outstanding, down 20 million from the same period one year ago. At the end of the quarter, we had 566 million shares outstanding on a fully diluted basis.
Slide seven shows the highlights of our balance sheet as of September 30th. Our balance sheet remains solid. Our operating working capital of $7.2 billion was down slightly from a year-ago period. Total debt was about $7.3 billion, resulting in net debt balance that is debt less cash of $6.6 billion. Our leverage position remains comfortable with a net debt to total capital ratio of about 27%. Our shareholders' equity of $17.6 billion was similar to the level last year. We had $4.8 billion available global credit capacity at the end of June. If you add available cash, we had access to $5.6 billion of short-term liquidity. Next, Juan Luciano will take us through a review of business performance. Juan?
Thanks, Ray Young. Please turn to slide eight. In the third quarter, we earned $541 million of operating profit, excluding specified items, down from $650 million in last year's third quarter. Third quarter adjusted segment operating profit was down 17% versus the year-ago quarter. Now I'll review the performance of each segment. Starting on Slide nine, Ag Services results were down compared with the strong prior year period. In merchandising and handling, North America grain results were negatively impacted by the lack of competitiveness of U.S. Corn and soybeans in global markets. This led to a significant reduction in margins and a decrease in export volumes. Global trade generated positive earnings as our improvement actions are taking hold.
While results declined from the third quarter of 2016, global trade benefited from international origination margins and the expansion of destination marketing businesses, offset by some losses incurred due to a lack of correlation on certain hedge positions. Transportation results decreased from the prior year period due to a slower start of harvest in North America, which led to lower barge freight volumes and margins. Milling and other earnings were down due to lower volumes, though the business was still a strong contributor and maintained steady product margins. Please turn to slide 10. The Corn processing team delivered another strong quarter with results up from the year-ago period. Sweeteners and starches had a solid performance with strong margins bolstering the North America business and our international operations continuing to provide solid contributions to overall results. Bioproducts results were substantially higher than the year-ago quarter, with ethanol benefiting from higher margins.
Animal nutrition was up over the previous year, with specialty feed ingredients benefiting from an improving cost position despite lower amino acid prices. Slide 11, please. Oilseeds processing results were lower for the quarter in an extremely challenged operating environment. Crushing and origination results were down. Globally, crush margins remain compressed with ample meal supplies. In North America, results were impacted by weak canola margins, partially due to higher seed costs. Our European processing business was down amid competition from significantly increased flow of meal imports from Argentina. In South America, origination remained tight due to continued low commodity prices that reduced the pace of farmer commercialization, forcing higher basis costs. Refining, packaging, biodiesel, and other results were lower for the quarter. Biodiesel was substantially lower than the year-ago quarter, primarily due to mark-to-market timing losses in the current quarter and weaker margins.
Asia was up over the third quarter of 2016 on Wilmar results that were lower than anticipated, but still substantially higher than last year's quarter. On slide 12, WFSI was down over the prior year period. The WILD Flavors team delivered double-digit operating profit growth, driven by strong sales in Asia and the EMEA region. I have been very encouraged with the expansion of our customer base and channels, and our focus on global accounts and targeted segments. On a year-to-date basis, our WILD Flavors sales revenues are up more than 5% on a constant currency basis. While sales revenues for specialty ingredients was slightly up for the quarter, overall operating profit results were down. We continue to work through the startup of our Campo Grande and Tianjin facilities, which had a negative impact to our third quarter results.
It's important to remember that Campo Grande is not really one facility. It's a complex of several different production lines, all of which are interconnected. Five of the six lines are now operational, and we expect the sixth to be online before the end of the year. In Tianjin, we are continuing to work through production bottleneck issues at our specialty fibers facility. Setting aside the startup issues, the specialty ingredients business is having a good year growing, with sales revenue up for specialty proteins, edible beans, emulsifiers, natural health and nutrition, and fibers. Please turn to slide 13 for an update on some of our actions this quarter. We are continuing to execute in our three primary areas of focus. We have exceeded $300 million of monetizations in 2017, and thus achieved the two-year, $1 billion monetization target that we announced in 2016.
In Project Readiness, we continue to make significant investments to roll out lean manufacturing processes across our facilities and standardize our business systems. We have generated operational cost savings of almost $200 million on a run rate basis, and are on pace to exceed our 2017 target of $225 million. Our One ADM business transformation initiative went live in its second processing business, and we are in the testing and implementation phases of our first European launch set for the first half of next year. In Germany, we're expanding our capabilities to meet regional demand for non-GMO soybean products, and we're upgrading our Midwest milling operations. This highlights several of the actions we took in the quarter. We'll continue to update you on our progress as usual.
Before we take your questions, I would like maybe to spend some time offering additional perspectives on the balance of the year and 2018. In Ag Services, we expect solid North American soybean exports and improved results in global trade, partially offset by continuing challenges to North American corn exports due to the competitiveness of the South American corn crop in export markets. Generally, we think Ag Services' Q4 performance should be similar to the prior year period. In corn, we are seeing weaker ethanol margins, which should be partially offset by stronger results from Sweeteners and Starches and Animal Nutrition. That will likely lead to a fourth quarter that will be lower than Q4 2016. I would also add that in Sweeteners and Starches, we are pleased with the good start of 2018 contracting.
In Oilseeds, global market conditions will continue to impact crush and origination, including South American origination, although seasonally, our North American crush operations should experience higher volumes than in the third quarter. Our value-added oilseed business should deliver a solid performance. Taken altogether, we think Oilseeds is likely to deliver a similar fourth quarter to the year-ago period, excluding any benefits that we may experience if the biodiesel tax credit is approved retroactively for this year. In WFSI, we expect WILD Flavors to continue its growth momentum in the fourth quarter, and the specialty ingredients business should see improving results and increased contributions from our new facilities. All told, we think WFSI is likely to be higher in the fourth quarter than the year-ago period. Looking into 2018 and beyond, we see several important factors that will positively impact value creation and growth.
In terms of market conditions, while we expect some of the conditions that have impacted recent results could persist into next year. We are beginning to see green shoots of indications that point to some improvement in the margin structures of our origination and Oilseeds crushing businesses. For example, global stocks of soybeans and corn are expected to start coming down after a period of buildup, amid an environment of strong global demand growth. The impact of competing feed proteins to soybean meal appears to be lessening. More importantly than external conditions, however, we believe that 2018 will be the year that we start to benefit from the full impact of recent investments and many of the aggressive actions we have taken in recent years. Let's take them one at a time.
First, as I already mentioned, we will begin harvesting the fruits of the investments we have made over the past years. We will see increased contributions from facility startups, particularly Campo Grande, throughout 2018, but also improvement in earnings from the Tianjin China complex and various investments across all four of our business segments. We're not anticipating any significant startups or acquisition integrations that would drag down earnings in 2018, unlike what we saw in 2016 and 2017. Second, we'll be completing the implementation of the cost and efficiency actions that we announced last quarter, and they will deliver increased benefits next year. Third, we expect to see continued growth in contributions from the longer-term transformation and investments we have made since 2014, as our portfolio management actions and our operational excellence achievements all deliver increased benefits.
All of this, combined with strong demand, provide us with a positive outlook for 2018 and beyond. Although we mentioned some green shoots in Ag Services and Oilseeds, we are not counting on significant changes in operating conditions. Therefore, we are taking further actions. We will reduce our overall capital spending level to approximately $800 million in 2018, from the recent historic levels of closer to $1 billion, as part of harvesting the benefits of recent investments. More importantly, we are reallocating capital spending away from the origination and Oilseeds crushing businesses, where generally there is adequate capacity, toward the value-added businesses in support of the growth portion of our strategic plan.
All told, we expect a period of stronger cash flows and returns, lower CapEx needs, and an environment of strong growth demand, all of which will benefit our shareholders and place ADM on a future path of growth. With that, operator, please open the line for questions.
Thank you. At this time, if you'd like to ask a question, please press *1 on your telephone keypad. We ask that you please limit yourself to one question and one follow-up question. Your first question comes from the line of David Driscoll with Citi. Your line is open.
Great. Thank you, and good morning.
Hey, good morning, David.
Thanks, guys. Can you give us just a little bit of quantification for the one-time cost associated with the recent investments, things like startup costs that have and will occur in 2017, but won't reoccur in 2018? Related to that, can you also just talk a little bit more, with quantification, about the operating profits that you expect that these investments could generate next year?
Yes, David, thank you for the question. We've been talking about Campo Grande and Tianjin. It's just not only that, it's also we've been building the capabilities in this business. It's a business that its value proposition is resonating very strongly with customers. We are having a lot of success in generating new projects in terms of systems and solutions for our customers as they seek higher growth rates. This facility, Campo Grande, for example, in Brazil, will be the best specialty proteins facility in the world. It's six facilities integrated, very sophisticated, complex, and I'm very pleased to say that we are in the fifth stage out of six, we have only one more to bring to operations in the last quarter. We also built three customer innovation centers with rapid prototyping capabilities.
We have one in New Jersey here in the U.S., we have one in Australia, we have another opening up now in November in Singapore, and we're going to have another one in South America. When you put all these things, David, together, probably for 2017 so far, it has impacted operating profit, but about $30 million. That's a significant number for a business that is relatively new. We're very pleased the way WILD Flavors shall be holding that with double-digit operating profit growth and certainly growing at revenue at the rate of 5%. We expect all these facilities that during 2016 and 2017 have been a headwind to that business to actually become a source of profit in 2018.
To be honest, it's not only the cost of those facilities I'm bringing there, you have also the cost of the facilities you use to actually fit the market for those facilities, where you lose your normal profit because you take on businesses that have higher freight, if you will. Also, these facilities have taken a lot of management attention as we bring the leadership ranks of these, and we bring the facility to life. Again, they probably mute how excited we are about WFSI. WFSI on a customer front is hitting on all cylinders, and we'll feel very proud and very excited about that in 2018.
Just to be clear, you're saying that in 2017, all these investments result in about a negative $30 million impact headwind to the business, and much of this is one-time in nature. When we go to 2018, those startup expenses go away, and then these businesses actually, can they produce positive operating profits on their own outside of the startup expenses? We would take that negative $30 million, reverse it, and then add to it some reasonably, in relation to that $30 million of positive impact from all those investments. Is that the right way to think about the 2018 impact?
David, that is correct. Normally, it takes us. We decided on a bolt-on and organic growth strategy because we thought M&A in this space was too expensive right now. We think it's more value creating. I think the issue that this is more value creating long term, but it's probably more painful short term, because every time you build a plant, you have 18 months of basically build and cost. Then the forward six months or nine months after startup, you're not making your full range of profits from this product. Again, with differing contributions, your assessment is correct. We're going to see the reversal of those costs that will not happen there, and we're going to start seeing positive contribution from those investments through 2018.
Thank you, guys. I'll pass it along.
Thank you, David.
Your next question comes from the line of Ann Duignan with JPMorgan. Your line is open.
Good morning.
Good morning, Ann.
Morning, Ann.
Just to start, just some clarification, you noted that you expect corn performance to be lower in 4Q than a year ago, I don't think you told us why, specifically the volume.
Ann, I think it's about ethanol. If you look at, for example, the same quarter last year, Q4 last year was a strong ethanol margin environment, probably in the range of maybe $0.20 or something like that. We are looking more now in the single-digit type of margins going into Q4. That's the biggest delta. It will be offset partially, Ann, by a stronger performance in Sweeteners and Starches and better Animal Nutrition results as we have improved our cost position there. All in all, we'll not be able to offset the strong ethanol performance of the same quarter last year. That's what we're saying.
Okay. I appreciate the color. On the reallocation of CapEx away from Ag Services and into the growthier businesses or the value-add businesses
Yes
one, is this an acknowledgment that Ag Services is facing some structural headwinds, just given the global glut of all three soft commodities?
Yeah, Ann. I think we have acknowledged that there is a part of Ag Services that is suffering, as you describe, some structural issues. I will say, when we said the reallocation of capital, a couple of things at that. First of all, we do believe that the growth of production over the coming years will come from more yields and less geographic expansion. As such, we don't foresee to have to build elevators or ports in other areas. We have built, as you know, El Tránsito in Argentina, and we are investing in Santos and Barcarena in Brazil. We feel that we are complete from that perspective. Destination marketing, which is our effort there, doesn't require the same amount of capital. In general, we don't see that much of a need.
If you think about even export capacity in North America, there is enough export capacity if the U.S. will not have simultaneous exports of soybeans and corn, because we expect South America to be competitive in corn through the first quarter. That's how we're thinking about it in 2018. We feel that we need less capital going forward in that business.
Okay. I appreciate the color. I'll get back in line in the interest of time. Thank you.
Thank you, Ann.
Your next question comes from the line of Adam Samuelson with Goldman Sachs. Your line is open.
Yes. Thank you. Good morning, everyone.
Morning, Adam.
I guess the first question on Oilseeds, coming back to the 2018 comments, generally, you said, seeing some possible benefits of green shoots, not counting on significant change. You've talked about redirecting capital away from Oilseeds. Now, can you talk about the path to the business realizing a higher capacity utilization, both your own and at the industry level, to improve the crush margins? Does the tension have to come from reduced Argentinian exports? Is it just you need a couple more years to grow into the meal demand? Can you help me think about the bridge to a better oilseed environment from where we are today?
Yeah, sure. A couple of things that we're seeing here. First is global meal demand is expected to accelerate in the near term. Obviously, our customers are very strong, they're seeing a strong profitability at this point in time. We've seen global animal protein production growth, some of them have actually announced increasing productions in new plants. We see that coming soon. The other thing that we are seeing less of, that I see a lessening effect, are some of these substitutes. If you think about the impact of competing proteins that we have last year or this year between DDGs and feed wheat, we see that lessening, we think that's going to continue to help the business. Think about the demand we're seeing in China being very strong for protein.
If you think about so far this year, when you compare to last year, crush in China has increased 11%, soybean meal destination stocks have basically stayed flat. It means there has been a true demand growth of 11% in China, which is very strong. We started to see also, in general, that price is working its way through the cycle. Price is creating less production, if you will, in some marginal areas, but it's also increasing demand. It takes a while for soybean meal prices to work its way into the ration. We always have to remember that these prices of meal is always the preferred choice to feed any of these animals. It's the gold standard. At equal prices or at lower prices, certainly it's going to come back into that.
This is just a little bit the green shoots, the environment. Of course, the business has made several improvements as they went through the year. They have looked at their facilities, they have optimized some things that they needed to be optimized, and they continue to be very excited about the possibilities that the value add continues to bring into the business. It has been performing very well. It's been the second-best year of that business. I would say, with a little bit of a reduction in the substitute milk feeding products, we expect Oilseeds to become a bigger contributor in profit than they were in 2017.
Okay. Just the second question, because in the last couple of years, you talked to this earnings construct of, call it a $2.30 or so EPS base with a $1 to $1.50 of earnings improvement from things that you could mostly control.
Yes.
Has the experience year to date in 2017 led you to change the view of the base or the timing of how long it could take to realize some of those earnings growth?
No. Listen, let's review the four buckets for a second so for everybody's sake. The first bucket was WILD Flavors at $0.10 per year accretion. WILD Flavors has been growing operating profit 20% every year that we own them. We are very happy with that. That's going in the right direction. The second bucket was operational excellence, and we continue to deliver those $100 million of run rate improvements every year. That's on track. The fourth bucket was, and I'm going to get back to the third one in a second, but the fourth bucket was buybacks, and obviously, we're generating the cash flow to do that. The third bucket is where I think I need to call your attention, and that's the one that's coming a little bit slower. Just because we mentioned the contribution of those assets, they were $0.10 on average.
The problem that we have, I explained before when I answered David's question is, in order to get those $0.10, you go through a couple of years in which you have negative impact to the P&L because you're building that plant. In reality, that hits you a little bit later. We took those charges in 2016 and 2017 as we were building those projects. That's why, to a certain degree now, we are turning a page from that period of investments and having those costs that we never adjusted out because they are normal cost of operations. Now in 2018, we're not going to have all those. We were integrating small acquisitions, and we were building plants.
Now you're going to see that third bucket hitting our P&L on a positive perspective from 2018 or from Q4 onwards versus what it was a negative impact, if you will, during 2016 or 2017 as we were investing. This was a conscious decision, as I said before, because we thought that we have an opportunity there to grow. We needed to build the capabilities that, as I said, are resonating with the customers. We thought it was more value creating to do it organically than given the current multiples and to do it through an acquisition in the ingredient space.
Okay. That's helpful. I'll pass it on.
Your next question comes from the line of Kenneth Zaslow with BMO Capital Markets. Your line is open.
Good morning, everyone.
Morning, Ken.
Good morning, Ken.
Quickly, I guess what I think about is the Oilseeds business. You talked about the improvement or kind of holding it out next year. Can you talk about the new capacity that's coming online over the next, call it 12 months from AGP, Perdue, all that stuff, and how does that play out? It seems to me that the disconnect between the forward and the cash may be implied by that. How are you thinking about the recovery there with the new capacity coming online?
Yeah, Ken, it's Ray here. Clearly, there is capacity coming online, that's also a little bit of recognition that there is global protein growth around the world. You look at the trends, like 4%-5% growth in terms of meal demand and protein demand. From our perspective, some of the recent, the quarter's results, they've been impacted by other factors. Clearly, when we take a look at our results in Q3 for Oilseeds, we've seen that, as an example, a lot of pressure in terms of the South American crop impacting, particularly the European operations. A lot of meal, actually, from Argentina went over to Europe, and that actually caused us to have one of our lowest quarters from a crush perspective over in Europe. We actually think that over time will equalize itself.
We actually think production levels will adjust in order to take that into account. We've also seen, for example, in the Oilseeds results, part of it is just due to the simply South American origination. We actually entered the third quarter being more optimistic regarding farmer commercialization. In fact, at the time of the last earnings call, we were actually seeing some good movements in terms of the crops. What happened was the currency actually moved the other way as we moved through August, the farmers actually just really slowed down commercialization. That really resulted in our South America results being a lot lower than what we had thought. We also, in the case of Wilmar, they had a good quarter, but clearly below our own internal expectations, and it was about a $35 million impact versus our own internal expectations.
I think, Ken, when we look at the quarter, I think that there are certain factors that clearly impacted us. It doesn't really change our longer-term perspective on Oilseeds, which is really, demand continues to be robust for protein. We're seeing China continue to be very strong in terms of demand side. We do believe that while there's some capacity additions, we actually think that's going to be limited in some respects as the market really adjusts to the crush margin levels. I think we'll actually get to a level whereby there's going to be a better balance, and we're going to see industry margins actually recover in the crush business.
That's interesting. The second point of question I have is, when I think about China and the ethanol, where they're going to be in 2020, can you talk about the impact that would have on either corn, ethanol, and DDGs, and how that will affect your business?
Ken. Today, China consumption is about 2.6 million tons. Ethanol is accepted or used in about 11 provinces in the country. When they declare that they're going to try to be E10 by 2020, that means going from 2.6 that they are today to about 12 million tons. The current estimate of capacity being built there is that they're going to get to 4 million tons in 2019. The government has declared their intention that by 2025, I think, they would like to have it cellulosic ethanol. It seems difficult to see that if they're going to have 4 million tons of domestic capacity in 2019, and by 2025, they're going to be 100% cellulosic, that it makes sense to build 8 million tons of ethanol capacity for a couple of years, if you will.
Don't forget also, their ethanol is both corn and rice, I'm just assuming that everything is going to go corn. I think at this point in time, if I think about China, if ethanol is important for reducing pollution, there are going to be better ways to reduce pollution than using corn, because that is using a disproportionate amount of water that China doesn't have. If I'm a strategic guy in China, why would I use good water to grow corn? I'd rather go into electric vehicles or importing corn. To me, it's going to be more the impact of importing corn than actually the local production of DDGs. Naturally, if there is more consumption of production of domestic ethanol, you're going to have some DDGs.
I don't expect the impact at this point in time, given the numbers and given the dynamics I just described, to be big. I probably think that that's going to be a positive for us in terms of it's going to create a bigger ethanol market that every now and then, I think we're going to export to, like we've been doing to Brazil. I think it's going to take some imports of corn from the U.S. As I said, when you have 22% of the world population and 6% of the water, I don't think it makes a lot of sense to use that water to create a fuel that you're going to burn. I think you're going to use that water to feed your population.
You don't think they're going to end up using corn to make ethanol to reach that 2020.
I think they're going to use it, they can to reduce their stocks. I think on a forward basis, to me personally, it doesn't make a lot of sense, as I said, to use water for that. The inventory that they have that they need to reduce, sure, I think they're going to use that. I'm not sure they're going to be building a lot of plants beyond three or four million tons of capacity. I'm not sure I'm going to see 12 million tons of capacity in ethanol being built in China. That's what I'm saying.
If you have even that in the short term, wouldn't that create a lot of DDGs, which would affect the soybean meal demand? I know you said that soybean meal demand is going to be very strong. Is that not a competitor of it?
Yeah, I think in the short term, yes. All I'm saying is if they get to E10, that could be impactful. Right now, it could be a couple of million tons of DDGs, no more than that.
Okay.
It's not-
Perfect.
10 million tons of DDGs. That's what I'm saying. It's manageable.
Great. I appreciate-
With the crush, with the demand that is growing 11% per year, that I think is to me the most important factor when we think about China. If demand continues to grow, all these things are sorted out and will be absorbed.
Perfect. Thank you.
You're welcome.
Your next question comes from the line of Farha Aslam with Stephens Inc. Your line is open.
Hello, Farha. Are you there?
Hi. Good morning.
Hi.
Could we just continue on the ethanol question and just talk about potential of U.S. ethanol in Mexico? How is that market developing?
Yeah, in Mexico, as you probably heard, the government's actually looking towards introducing more ethanol into the market. There's about three cities that they're not looking to put in right now, but outside those three cities, we're looking to actually bring in additional ethanol blends up to 10% in those areas there. We're rather encouraged that we should see incremental growth in that area. I know there's been some talk regarding some injunctions out there. We think that's going to get sorted out. We do believe, for example, Mexico is one of these markets whereby vehicle sales will continue to grow, and basically consumption is going to grow in Mexico. Given the pollution considerations in Mexico, we believe ethanol is actually a fairly clean fuel that will actually help them address some of their pollution issues.
How much ethanol would you anticipate going into Mexico in 2019 and longer term?
I think it's about a couple of hundred million gallons. I think that's what we're thinking about right now.
Okay.
I think Farha, I think what you're going to see is that at the current prices that ethanol is trading in the U.S., I think we're going to continue to buy demand and to open up markets. We're trading, what, $0.30 below gasoline? Imagine versus all the other oxygenates. I think that between pollution in whether it's China, India, or Mexico, and the low price of ethanol, we're going to continue to see an export market that is going to be vibrant because we're going to open up new destinations.
That's helpful. Could we just talk about Ag Services/Oilseeds? Clearly the origination patterns for grain have changed in North America and South America, with farmers tending to hold onto their grains. How is ADM planning for the South American harvest differently this year versus the last harvest? How are you thinking about changing your organization in the U.S. to accommodate kind of more sporadic farmer selling rather than this consistent selling we saw historically?
Let me take a stab at that, Farha. In North America, I would say, we've seen a little bit of a shift maybe in the way the farmer uses ADM, if you will, and the times of the year in which the farmer uses ADM. Farmers that have consolidated, that become a little bit larger, maybe have less of a need in certain parts of the country for ADM to be in, for example, a truck elevator. We continue to be very important as a rail elevator, if you will, or as a processor or as an export terminal. We see how, for example, our marketing services, the marketing offering that we are giving the farmer has become much more complete and much more sophisticated as it has become more difficult for the farmer to make money.
The level of sophistication of how they need to make decisions has increased. In that, our relationship has become more sophisticated, if you will. I think that basic things like maybe drying or storage, sometimes we do less of, but we do more sophisticated things. We see, for example, the growth of our stevedoring operations, the growth of our destination marketing, the growth of our farmer services. That's an evolution that happened over time. It's not something that happened at one shot. In terms of South America and how are we dealing with that, South America has two elements. One is the pricing, and the pricing of the crop. The second is the currency. We are, of course, making decisions on how to handle that differently every year.
At times we get it right, and at times, maybe like this year, we didn't get it right. The teams are there continuing to look for that. Farmers have become larger. As I said, also in South America, the level of the discussion and the way in which they use our Ag Services continues to evolve into more sophisticated risk management, more sophisticated commercialization contracts that we have. As I said, some services that we are providing are giving us benefits that maybe we didn't get in the same proportion before. Like for example, in the U.S. The U.S. right now, being less competitive on a global basis, we are using a lot of our storage capacity for carries. Those carries are strong, and they're giving us maybe a higher % of profitability than maybe export margins were giving us last year, for example.
I would say it's a complex business in terms of it continues to shift and evolve, but maybe the problem that we're having with that is that some of this evolution doesn't happen as quickly as we would like in order to offset the decline. We are very pleased with, as I said before, with destination marketing, for example. It's growing 10% per year, and it's exceeding probably our expectations for two or three consecutive years. It takes time when all of a sudden you need to offset the fact that the U.S. is not competitive in corn, which is such a big volume crop. I think it's an evolution. I think over the couple of years, we are not worried about it. In the particular short term, it becomes a little bit more painful, like it happened in this quarter.
That's helpful. Thank you.
You're welcome, Farha.
Your next question comes from the line of Heather Jones with Vertical Group. Your line is open.
Good morning.
Morning, Heather.
I apologize if I'm asking questions that have been answered, but I was on another call earlier. Wanted to start with ethanol. Was just wondering if the recent EPA comments regarding the RVO and with biodiesel, ethanol, et cetera, do you think those targets, those mandates, are going to necessitate a much more aggressive rollout of E15 over the next two or three years? My math would suggest so, but I would love to get y'all's thought on that.
I just think that with the RVOs, we're talking about, again, 15 billion gallons in the case of ethanol here. We're seeing the U.S. gasoline, it continues to grow, albeit at a slower rate, but it continues to grow. On the export side, looking at next year, we're probably looking for some modest growth versus, say, the 1.3 billion gallons that we're seeing this year, 2017. We could be up to about 1.4 billion gallons. There's upside in terms of some other markets that will develop, such as Mexico. As Juan even indicated, in the case of China, they may decide to open up bringing in ethanol as opposed to growing corn, using their water in order to make their own ethanol.
Over time, we do see total demand for U.S. ethanol continue to move up over the medium term compared to where we are at this point in time.
I think I wasn't clear in how I phrased my question. I'm saying the 15-billion gallon mandate and the domestic use has fallen well short of that for a sustained period of time, and biodiesel has tended to fill that gap. As we get less imports in on the biodiesel side because of anti-dumping duties and all, it just seems like that gap is going to become more difficult for biodiesel to fill. My question is, do you think that's going to necessitate a more aggressive rollout of E15 here in the U.S. to meet that domestic mandate?
I think that, again, looking at domestic gasoline demand, currently about $14.4 billion in terms of the ethanol blend, that's probably going to move up to about $14.6 billion next year. Therefore, the demand side is moving up towards the $15 billion gallon level, which will be the mandate in 2018. We do believe that there is growth in the domestic market. It will be approaching the $15 billion gallon. You'll necessarily need to have some of the biodiesel in order trying to meet that particular, those RVOs there.
Okay.
Heather, I think if your question is if you see excess green inventories dwindle to lower levels, I think that blending of E15 and higher level blends will be required going forward, if that's what you're referring to the need
Yeah, that's what I want. Thank you.
I think that's a logical conclusion, we are ready to increase those levels from our perspective.
Okay. Moving to China, your comments on the meal demand there. Clearly, if you look at their poultry production, their beef production, just livestock production in general, it's not up that much. That growth is up actually less than 1%. The growth has been driven by commercialization of their livestock production, as well as a move into aquaculture. I was just wondering if you guys have any insight on how far along we are in that transition within their livestock production, so we get a sense of how many more years we have of that kind of robust growth there.
Yeah. I'm not sure that I have that level of granularity off the top of my head, Heather, to answer you. We may get back to you later on that. When I see production in the world, and we analyze that and macro numbers, I'm encouraged not only by the whole growth demand in China, but also the rest of the world. When you look at the next 10 years, it's a very significant percentage, and it's actually probably twice the size of the China market in that sense. We not only see that growth in China, and we promise we're going to get you the granularity on those by species in China, but also the rest of the world. Don't forget that. That is a significant number.
When you look at the macro numbers, Heather, to feed the world, we cannot forget some of these locations, when you add all up in 10 years, we need another Brazil in terms of production in order to feed the world. Think about that. We don't need Brazil to grow. We need another Brazil. Where we're going to get another Brazil is the biggest question, to be honest, not whether demand is going to be there, is where we're going to get another Brazil. That's what when you look at the demand in the rest of the world, if you think about in million tons, we're going to go in the rest of the world from at about 130 million tons to about 160 million tons in the next eight years or something like that. That's a significant number, and I'm not even mentioning China in that number.
We feel that the demand side is not going to be the problem. The problem is, can we adjust the supply side, and can we do it in a way that we can feed the world over the next eight to 10 years?
Okay. Thank you for that. My final question is sticking with Oilseeds in the U.S. Going back to Ken's question about expansion. The majority of this expansion is being done by smaller players.
Yep.
That's tended to be one of the problems in Brazil and Argentina is the fragmentation and the smaller players being less rational. I was wondering if that is a concern of you guys for North America, because it has been such a strong market. You paint a very convincing picture of the long-term demand outstripping supply, but was wondering if you have any concerns that over the next, say, two to three years, of there being at least some temporary dislocation in the supply-demand balance in the North American market.
Yeah, Heather. Always, as we look at the dynamics of every market, the competitive pressures we receive, we have some pressures coming at different times. As the last year, we feel the pressure of substitutes. Certainly, some of these smaller players trying to fill up their capacity will have to make their space at the beginning. We continue to have very well-integrated facilities, not only integrated with feedstocks, but also integrated into refineries with sewing capacity. We feel strongly about in the medium-term, long-term gain, we have the position to stay there. Will we have disruptions with some of these small players getting into the market? Yeah. They will be localized disruptions, and we will have to manage that. We tend to manage that. As I said, every year, there is something that we need to manage. Overall, I think we're going to be all right.
Okay, perfect. Thank you so much.
No worries.
Your final question comes from the line of Erik Larson with Buckingham Research. Your line is open.
Yeah. Good morning, everyone.
Hey, Erik. How are you?
Morning.
Morning, Erik.
I'm good, thanks. Say, I just want to talk a little bit more, just get a little bit more cadence on the Ag Services business in the quarter. I noticed in your working capital that it was a significant cash contributor in the quarter. This is typically a quarter where you start using a little cash, not obviously as significant as the fourth quarter. There were just so many moving parts in that Ag Services business in the third quarter. We saw significant farmers selling early on in the quarter. We had the water problems on the Mississippi and the Ohio, raised our costs, so we were even less competitive in export markets. We had a delayed harvest. It was just a whole confluence of just unusual events year-over-year.
You mentioned that your storage numbers should look pretty good, which I would absolutely agree to. Can you just kind of Connect the dots for us, Juan or Ray, as to the dynamics in that third quarter, and you gave us a little bit of what the fourth quarter is going to look like. How does this all play out for 2018 for your Ag Services with a very unusual third quarter?
Just maybe some perspectives on the third quarter. First of all, you're right. It's actually a favorable environment for us to have ownership. When you actually take a look at our inventory levels, it actually went up. We actually did have good ownership in order to take advantage of carries. Now, our total working capital did not go up because we actually managed the rest of their working capital, including receivables and payables, very, very effectively to offset the increase in terms of ownership that we had on the inventory side. The other aspects of Ag Services in the third quarter was, clearly it was below our expectations. A part of it is just due to the fact that just handling volumes were actually down during the quarter versus our initial expectations. In fact, handling volumes were about down 20% versus where we thought we would be.
With lower volumes, that had an impact on our margins. Our average margins versus where we thought we would be, were about 50% lower in the U.S., just a lot of it's volume driven. The other factor is like in global trade. We had a very good quarter in global trade, we kind of had a one-off item here in the sense that we had some hedges on some Black Sea sales on both corn and wheat. We hedged it off of some North American exchanges, and there was a kind of lack of correlation between the hedge and the underlying movement. That was over a $20 million impact for us, which is within the quarter here. As we kind of look forward, we do have good ownership. There are carries in the market.
We know our volumes are going to be moving up in the fourth quarter, both in terms of soybean handling and even in the case of corn, we're actually starting to see U.S. corn becoming more competitive in December now. That's going to be a positive story for us, and that's what gives us more confidence. Frankly, we also have more visibility in terms of our book looking into the last two months of this year than we had in terms of visibility looking into August and September at the time of our second quarter earnings call. That's what gives us more confidence in terms of Ag Services for fourth quarter in terms of an improvement versus what we're seeing right now. Looking into 2018, again, it's still early into 2018, we do believe that our strong ownership position will carry into the new year.
Frankly, we're still seeing great global demand. That should translate into some good numbers. We're seeing stocks-to-use ratios maybe stabilizing, maybe coming down. That could also point towards a situation whereby the markets may actually start normalizing a little bit and provide us with more opportunities in order to merchandise.
Thanks, Ray. I got the sense that your book has to be better as well as your carries. Obviously, we can see that in the cash market. That's what I thought was the answer, and appreciate the clarity. Thank you.
Thank you, Erik. Hello? Hello? Operator? Okay, Jack. Thank you.
I do apologize. It seemed like the backup line was playing music.
Okay. Thank you, Jack.
I would now like to turn the call back over to Juan Luciano for closing remarks.
Thank you, Jack. Thank you for joining us today. Slide 15 notes an upcoming investor event where we'll be participating in Chicago. As always, please feel free to follow up with Mark if you have any other questions. Have a good day, and thanks for your time and interest in ADM.
This concludes today's conference call. All participants may now disconnect.