Archer Daniels Midland (ADM) is a world leader in agricultural processing. It operates on six continents, is headquartered in Chicago, and has about 40,000 employees.
As always in analyzing stocks, I will use the approaches described in these Dividend Growth Investing Lessons:
• DGI Lesson 14: Grading Dividend Growth Stocks to Find the Best Ones for Your Portfolio
• DGI Lesson 11: Valuation.
ADM’s Dividend Record
ADM’s dividend resume is a bit uneven. Strong points include:
• Yield, which at 3.5% is almost twice as high as the S&P 500.
• 44 consecutive years of raising its dividend.
• Very Safe dividend rating from Simply Safe Dividends. (For more insight into dividend safety, see Dividend Growth Investing Lesson 17.)
ADM’s pace of dividend increases has slowed in the past few years. After increases of 26% in 2014 and 17% in 2015, ADM’s last four annual increases have been 7.1%, 6.7%, 4.7%, and 4.5% earlier this year.
Given ADM’s 44-year increase streak and high dividend safety score, I don’t see the growth slowdown as anything to be alarmed about.
That’s why I called the slowing of recent increases “OK” in the table above.
You can see that with its steady increases, ADM’s current yield is near a 10-year high.
That helps with ADM’s valuation, which we’ll explore later.
What’s the Story? ADM’s Business Model and Company Quality
What’s the Story? ADM’s Business Model and Company QualityADM has built a vertically integrated global agribusiness with sourcing, processing, production, and transportation capabilities to meet the needs of customers on six continents.
Headquartered in Chicago, ADM has approximately 40,000 employees. It is the largest publicly traded agricultural products company in the USA. ADM operates a global network of more than 750 agricultural sourcing, processing, transportation, and storage facilities.
ADM categorizes its activities as follows:
• Origination: ADM buys, stores, cleans, and transports agricultural commodities. Its operations include grain elevators, processing facilities, railcars, barges, and trucks.
• Oilseeds: ADM has the world’s most diversified oilseeds business. Seeds that it processes include canola, soybean, sunflower, flax, and cottonseed. ADM originates, transports, crushes, and further processes them around the world. The end-products (meals and oils) are used in food, animal feeds, renewable fuels, and industrial products.
• Carbohydrate Solutions: ADM is the world’s largest corn and wheat processor, with the capacity to grind nearly 3 million bushels per day. One product in this segment is ethanol, which ADM delivers to refiners through a network of trucks, railcars, barges, and terminals. Ethanol is blended with gasoline in order to reduce environmental emissions.
• Nutrition: ADM produces specialty ingredients. Its products address nutrition, function, texture, and taste of foods. ADM considers this business to be “on trend” and an important growth driver.
Here is a graphic representation of ADM’s business.
[Source of all slides in this section]
And here is ADM’s global footprint.
ADM is an active acquirer of other companies and technologies. The following slide indicates its M&A activities since 2014.
The two big acquisitions on the above slide are Wild Flavors (2013) and Neovia (2018), both representing expansion into non-commodity businesses.
In 2019, ADM plans to open six new plants, five innovation centers and labs, make 17 acquisitions, and enter into four joint ventures.
This slide shows the evolution of ADM’s product mix over the past 14 years. Notice that corn processing and oilseeds have swapped places as ADM’s largest segment, and that nutrition has grown to be a 10% contributor to earnings.
The company has invested more than $5 Billion in growth projects since 2014, and it believes that the full impact of these activities will begin to impact its financial results in 2019 and 2020.
Morningstar awards no moat to ADM, stating that while it holds a solid position in global agribusiness – including its massive network of processing plants, storage facilities, mills, and port operations – its business is highly capital-intensive, many of its operations have razor-thin profit margins, and many of its products are commodities.
ADM’s Financials
I like to begin this section by seeing how Value Line rates the company’s overall financial strength. Then I go through specific financial metrics and see if I agree with their assessment.
Value Line gives ADM its second-highest Financial Strength grade.
The company has held that grade since 2012. Let’s look at the key financial categories and see if we agree.
Return on Equity (ROE) is a standard measure of financial efficiency. ROE is the ratio of profits to shareholders’ equity.
The average ROE for all Dividend Champions is 9%, and for S&P 500 companies it is about 14%. The following chart shows ADM’s ROE 2009-2018.
[Source of all yellow-bar charts: Simply Safe Dividends]
You can see that ADM’s ROE runs about average for Dividend Champions and a little below average compared to the S&P 500. Overall this is an OK record.
Debt-to-Capital (D/C) ratio measures how much the company depends on borrowed money. Companies finance their operations through a mixture of debt and equity (shares issued to the open market) as well as their own cash flows.
A typical D/C ratio for a large, healthy company is 50%.
The normal use of D/C is to gauge risk, because it helps determine how strong the balance sheet is. All else being equal, stocks with high D/C ratios are generally riskier than those with low D/C ratios.
ADM comes out well on this metric, with a D/C ratio below 30%. Moreover, it has held this position for several years. I think this suggests strong financial discipline at ADM and a disinclination to over-leverage itself.
Operating margin is one of my favorite financial metrics. It measures profitability: What percentage of revenue is turned into profit after subtracting cost of goods sold and operating expenses.
Per recent research, typical operating margins for S&P 500 companies have been in the 11-12% range. ADM’s margins are much smaller.
This is why Morningstar gives ADM a “no moat” rating as we saw earlier: Its margins are truly razor-thin.
Earnings per Share (EPS) is the company’s officially reported profits per share. We want to see if a company has had years when it officially lost money, or if its earnings are steadily increasing, declining, or flat.
ADM’s earnings have been consistently positive, but inconsistent in amount and growth. They have both risen and declined in four of the past nine years.
The company presents its earnings in 2-year rolling averages. This smooths things out somewhat, but it does not change the overall fluctuating picture.
CFRA’s forward estimates for EPS growth are in the 5%-10% range over the next two years.
Free Cash Flow (FCF) is the money left over after a company pays its operating expenses and capital expenditures. Whereas EPS is subject to GAAP accounting rules, cash flow is a more direct measure of money flowing through the company. It’s the money a company has available for dividends, stock buybacks, and debt repayment.
Excess FCF allows a company to pursue investment opportunities, make acquisitions, repurchase shares, and pay/increase dividends.
ADM’s cash flow record is erratic. In four of the past nine years, it has registered negative free cash flow. There is no consistent record of growth.
Share Count Trend shows whether the company’s outstanding shares are increasing, decreasing, or remaining flat.
I like declining share counts, because the annual dividend pool is spread across fewer shares each year. That makes it easier for a company to maintain and increase its dividend. By buying back its own shares, the company is essentially investing in itself and expanding each remaining share into a larger piece of the pie.
ADM has been retiring shares steadily since 2013. It has 15% fewer shares in circulation now than at the end of 2012.
As with its modest debt, this metric tells us that ADM runs itself with a great deal of financial discipline. It is not constantly issuing new shares to shore up its finances.
Here is a summary of the items above:
Taking everything into account, I think that Value Line’s A+ financial rating is too generous for ADM. I would give it a C+.
The company is clearly in a business that is financially challenging. Its performance is subject to cycles and factors outside its control, such as corn and other grain prices, trade wars, weather, and shifting consumer tastes. Ethanol is subject to myriad regulations.
ADM is diversifying into less commoditized businesses (such as flavors and animal nutrition), but its ability to integrate those businesses and operate them well is as yet unproven.
While ADM is to be commended for its balance-sheet discipline, including its ability to retire shares over the past few years, its margins are very low, and that makes everything difficult. Annual growth in earnings and cashflow are not assured, although the long-term trend is positive.
ADM’s Stock Valuation
I use four different approaches, then average them out.
Step 1: FASTGraphs Basic. The first step is to compare the stock’s current price to FASTGraphs’ basic estimate of its fair value.
The basic valuation estimate uses a price-to-earnings (P/E) ratio of 15, which is the historical long-term P/E of the stock market, to create a basic “fair value” reference line.
In the following chart, the fair-value reference line is orange, the black line is ADM’s actual price, and I circled ADM’s current P/E ratio.
Since the black price line is below the orange fair-value reference line, ADM is undervalued by this first method.
To calculate the degree of undervaluation, we make a ratio out of the P/Es.
Calculating Valuation Ratio from FASTGraphs
Actual P/E ratio / Reference P/E ratio
12.3 / 15 = 0.82
That suggests that ADM is undervalued by 18%.
We calculate ADM’s fair price by dividing the actual price by the valuation ratio. We get $40 / 0.82 = $49 for a fair price.
Note that I round dollar amounts to the nearest dollar to avoid creating a false sense of precision. Since valuation involves future events, it cannot be precisely known.
I believe it is a good idea to keep the uncertainty of valuation in mind as an investor. We’re not measuring a physical trait like length or width. We are making a value judgement.
Different methods and models will come up with different results. That’s why I average four models.
Step 2: FASTGraphs Normalized. The second valuation step is to compare the stock’s current P/E to its own long-term average P/E.
This step paints a similar picture to the first step and suggests that ADM is even more undervalued.
ADM’s 5-year average P/E is 17.0 (circled). The blue fair-price reference line is drawn using that P/E. Again the black price line is below the blue reference line.
Using the same calculation methods as above, we get the following results for ADM’s valuation.
• Valuation ratio: 12.3 / 17.0 = 0.72
• Fair price: $40 / 0.72 = $56
This suggests that ADM is selling at a 28% discount.
Step 3: Morningstar Star Rating. Morningstar takes yet a different approach to valuation.
They ignore P/E ratios and instead use a discounted cash flow (DCF) model for valuation. Many investors consider DCF to be the best method of assessing stock valuations.
In a nutshell, the DCF model is based on the idea that a company is worth all of its future cash flows (or earnings), discounted back to the present to reflect the time value of money.
Obviously, no one actually knows a company’s future cash flows. Estimates must be used. My experience with Morningstar is that they have an admirably comprehensive and conservative process.
Morningstar gives ADM 3 out of 5 stars, meaning that they consider the stock to be fairly valued. Here is a 6-year graph of their fair value estimates (red line) compared to the stock’s price (black).
Specifically, they calculate a fair price of $46. While ADM’s actual price is 12% below that, Morningstar’s range of “fair” value encompasses that gap.
Step 4: Current Yield vs. Historical Yield. My last step is to compare the stock’s current yield to its historical yield. This way of estimating fair value is based on the idea that if a stock’s yield is higher than usual, it may indicate that its price is undervalued.
This chart shows ADM’s current yield (green dot) compared to its 5-year average yield.
[Source: Simply Safe Dividends]
ADM’s 5-year average yield is 2.9%, while its current yield is 3.5%. When the current yield is higher than the historical average, that suggests that the stock is undervalued.
As with the other methods, we can make a valuation ratio out of these numbers.
Calculating Valuation Ratio from Yield Comparison
Historical yield / Current yield
2.9% / 3.5% = 0.83
That suggests undervaluation of 17%, which in turn suggest a fair price of $48.
Valuation Summary:
The bottom line on my valuation is that ADM is 20% undervalued, with a fair price of $50. That has to be considered a good deal if you like the company.
Miscellaneous Factors
Beta
Beta measures a stock’s price volatility relative to the S&P 500. I like to own stocks with low volatility for 2 reasons:
• They present fewer occasions to react emotionally to rapid price changes like sudden price drops that can induce a sense of fear.
• There is industry research that suggests that low-volatility stocks outperform the market over long time periods.
ADM’s 5-year beta is 1.0, which means its volatility has been, on average, similar to the market’s.
This is a neutral factor.
Analyst’s Recommendations
In their most recent report on ADM, CFRA averaged the recommendations of 14 analysts. Their average recommendation was 4.0 on a 5-point scale, which translates to “buy/hold.”
This is a slightly positive factor.
What’s the Bottom Line on ADM?
Here are ADM’s positives:
• Strong dividend record: Good yield (3.5%) combined with a 44-year streak of increases, many of which have been in double digits. Yield is at a multi-year high.
• “Very Safe” dividend safety grade of 94/100 from Simply Safe Dividends, suggesting that the dividend is well-supported and unlikely to be cut.
• Global agribusiness that includes established customer and supplier relationships, and large established infrastructure. Size gives it advantages of scale.
• Pursuing acquisitions and intiatives to expand into less commoditized businesses.
• Investment-grade credit rating from S&P, high Safety rating from Value Line.
• Good record of positive earnings, moderate debt, and steadily declining share count.
• Shares are 20% undervalued.
And here are ADM’s negatives:
• Products are mostly commodities with single-digit profit margins.
• Despite its scale, ADM has little pricing power with many of its products, which can be impacted by uncontrollable factors like weather and regulations.
• Unproven ability to integrate non-commodity businesses it has acquired.
In my opinion, ADM presents a solid dividend growth opportunity, based on its good yield, long track record of raising its dividend, established business model, and 20% undervaluation.
Here are other discussions of ADM on Daily Trade Alert.
• Tara’s Breakout Stock Alert: Archer Daniels Midland (ADM) (Tara Young, May 2019)
• 5 Dividend Aristocrats that Pay Double the Club’s Average (Brett Owens, March 2018)
• Jason Fieber’s Fire Fund contains ADM.
Remember that this is not a recommendation to buy, hold, or sell ADM. Always do your own due diligence. Think not only about the company’s quality, dividend outlook, and business prospects, but also about how and whether it fits your personal financial goals.
— Dave Van Knapp
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