Archer-Daniels Midland (ADM, Financial) is one of the largest and best food processors in the world. It buys corn, wheat, cocoa, oilseeds and other agricultural products and processes them into food, food ingredients, animal feeds and biofuels. It also resells grains on the open market.
Unlike most food processors that produce final consumable goods, Archer-Daniels Midland is primarily a producer and distributor of intermediate goods for further food manufacturing and is by far the largest publicly traded company in the business.
Among the most significant products in its portfolio are vegetable oils, protein meal, corn sweeteners, flour, biodiesel, ethanol and other food and animal feed ingredients. Foreign sales make up the majority of total revenue.
The company is vertically integrated and owns and maintains most facilities used throughout the production process. Operating facilities are located in more than 79 countries on six continents with 270 processing plants. It also owns and operates an extensive water and ground-based distribution network, including more than 26,000 railcars.
The company's operations are classified into three reportable business segments: Oilseeds Processing, Corn Processing and Agricultural Services. The Oilseeds Processing segment undertakes activities related to the origination, merchandising, crushing and further processing of oilseeds such as soybeans, cottonseed, sunflower seed, canola, rapeseed and flaxseed into vegetable oils and protein meals. The company's Corn Processing segment undertakes corn wet milling and dry milling activities and converts corn into sweeteners and starches and bioproducts. Its products include ingredients used in the food and beverage industry including sweeteners, starch, syrup and glucose.
The Agricultural Services segment is the company’s storage and transportation network. This business is primarily engaged in buying, storing, cleaning and transporting grains to/from Archer-Daniels Midland facilities and for export.
Purchase considerations
Agriculture products remain key necessities across the planet, and this isn’t going to change anytime soon. Increased demand for food and rising income levels in emerging markets will bode well for Archer-Daniels Midland.
The company continues to have a strong presence in the biofuels industry, and while the profit potential in this segment has declined and is far more volatile now than it was eight years ago, competitive advantages derived from experience and scale will provide some margin protection.
The current shakedown in the industry has made it difficult for many of the smaller players to continue to compete and have been exiting the market. The industry is highly concentrated with only four major suppliers dominating the world market, providing Archer-Daniels Midland and the other three players with monopolistic-type pricing power.
Growth through acquisitions will definitely continue, and Archer-Daniels Midland will be active in this space and has shown fairly good returns on acquisitions in the past. Archer-Daniels Midland continues to grow in emerging markets of Asia, South America and Eastern Europe. Sales growth outside the U.S. has outstripped domestic growth, and Archer-Daniels Midland’s distributional advantages provide it with operating and cost advantages over much of the competition, many that operate in only niche markets. We like the company’s strong record of dividends and dividend growth as it provides a nice cushion against cyclical falls in commodity prices.
Valuation
The figure below provides a snapshot view of Archer-Daniels Midland’s high-low stock prices and diluted earnings per share for the last 20 years (the same snapshot is provided for sales, book value and free cash flows, but our focus will remain on earnings). The high-low stock prices were indexed and scaled to 1996 — this indexing allows us to better track changes in the stock’s normal trading range in relation to EPS growth.
Visually, buy-sell signals can be determined by identifying spreads in the EPS series and the stocks’ trading profile. Buy signals are triggered when the EPS line breaks away on the upside from the high stock price. Sell signals are triggered when the EPS line breaks away on the downside from the low stock price.
Diluted EPS and high-low stock price profile (indexed to 1996)
Buy-sell zones
At today’s levels, Archer-Daniels Midland's stock trades at 17.6x trailing 12-month earnings per share of $2.63 and 17.1x fiscal 2016’s estimated earnings per share of $2.28. Based on a quick visual valuation, Archer-Daniels Midland appears to be slightly undervalued relative to current earnings but is approximately fairly valued relative to expected future earnings. It appears slightly undervalued relative to the Standard & Poor's 500 average multiple of 23.3x.
With the multiples above, a PEG ratio of 1.01, consensus EPS estimates of $2.28 for 2016 and $2.80 for 2017, Archer-Daniels Midland’s stock would normally command a fair multiple of 12.9x to 18.3x EPS. This seems well aligned with its long-term historical multiplier trend and values its shares at between $36.06 and $51.24 by the conclusion of fiscal 2018.
Cautionary notes
The company is still in the process of fine-tuning its business mix and needs to more actively divest itself of smaller low-margin product lines in favor of higher value added food goods.
It is blatantly apparent how sensitive Archer-Daniels Midland is to swings in the commodity cycle with falling prices having a major impact on the company. That being said, the worst is over. Still, it might take some time before Archer-Daniels Midland is operating at full capacity and stockpiles are scaled down.
It’s also hard to ignore the company’s growing stock price volatility with its Beta growing from 0.6 in 2014 to 1.2 in 2016. Archer-Daniels Midland’s acquisition strategy needs to be well controlled so as not to diversify into poorly performing industries.
The stock price has performed reasonably well and has grown 14% over the last year. Given this recent momentum, pick your entry points carefully.
Last, Archer-Daniels Midland is heavily invested in the corn-ethanol-fuel processing chain. This is a very tight-margin product line. Increased softness in demand and/or lower prices could easily devastate earnings in a given quarter or two. In addition, the company’s success in the high fructose corn syrup market could suffer from the growing nutritional health trend in the food and beverages industry.
Disclosure: We do not currently hold any position in Archer-Daniels Midland.
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