Published by Nick McCullum on June 17
Dividend history matters. Here’s why.
A long streak of steadily increases dividends is indicative of three important business qualities:
- The business is doing well.
- The business has done well over many business cycles.
- The company’s management is very shareholder-friendly.
The best list for finding high-quality dividend stocks with long histories of steadily increasing dividends is the Dividend Aristocrats list. To be a Dividend Aristocrat, a company must:
- Be in the S&P 500.
- Have 25+ consecutive years of dividend increases.
- Meet certain minimum size & liquidity requirements.
Having 25 or more years of steadily increasing dividends means that a company has endured (and often thrived) through many difficult market cycles. So, when a Dividend Aristocrat is experiencing temporary business trouble, it is often a fantastic buying opportunity for investors.
Archer-Daniels-Midland (ADM, Financial) is one example of a Dividend Aristocrat that is having some troubles right now.
As a globalized agriculture company, Archer-Daniels-Midland is very exposed to fluctuations in worldwide commodity prices. Right now, commodity prices are at relative lows (shown below), creating a headwind for this company.
Source: AMIS Market Monitor
But – make no mistake – the company’s long-term growth prospects are as strong as ever. Furthermore, commodity prices have caused downward pressure on Archer-Daniels-Midland’s stock price, creating a buying opportunity for long-term investors.
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.” – Warren Buffett
Fortunately, Archer-Daniels-Midland is far from being “on the operating table”. Investors should view the current commodity price environment as a compelling buying opportunity in this high-quality dividend stock.
Business overview
Archer-Daniels-Midland is one of the world’s largest agricultural companies with a market capitalization of $24 billion.
The company is in the business of processing oilseeds, corn, and other commodities as well as manufacturing by-products like sweeteners and biodiesels.
Archer-Daniels-Midland has a very global business model – 47% of 2016 sales were generated outside of the U.S.
Archer-Daniels-Midland operates in four core operating segments:
- Agricultural Services.
- Corn.
- Oilseeds.
- Wild Flavors and Specialty Ingredients (WFSI).
Each segment’s contribution to adjusted operating profit over the past five quarters can be seen in the following diagram.
Source: Archer-Daniels-Midland First Quarter Earnings Presentation, slide 8
Current events and growth prospects
As mentioned, Archer-Daniels-Midland is experiencing a temporary profit downturn due to low agricultural commodity prices.
However, a meaningful turnaround can be seen in the company’s recent financial performance.
In Archer-Daniels-Midland’s first quarter financial release, the company noted adjusted EPS up 42.9% from the same period a year ago.
This impressive performance was driven by improved fundamental performance in each of the company’s operating segments.
The company also continued to place its shareholders’ interests first by returning more than $400 million to its shareholders in the quarter through a combination of share repurchases and dividend payments.
Source: Archer-Daniels-Midland First Quarter Earnings Presentation, slide 3
Archer-Daniels-Midland’s near-term growth prospects are based on a turnaround in global crop prices.
Longer term, growth will be driven by growing populations and an increasing demand for food. The global population is expected to reach 9.7 billion in 2050, and Archer-Daniels-Midland’s globalized business model makes them well-positioned to capitalize on this growth.
Competitive advantage and recession performance
Archer-Daniels-Midland’s competitive advantage comes from its impressive scale as the largest processor of corn in the world.
The company’s vast array of worldwide operating assets – 428 procurement locations, 280 manufacturing facilities, 39 innovation centers – creates a barrier to entry for potential competitors in this capital-intensive industry.
Archer-Daniels-Midland is very resistant to recessions in the broader global economy. The company reported steady or rising adjusted earnings-per-share each year during the great recession of 2008-2009. This can be seen below.
- 2007 adjusted earnings-per-share: $2.38.
- 2008 adjusted earnings-per-share: $2.84.
- 2009 adjusted earnings-per-share: $3.06.
- 2010 adjusted earnings-per-share: $3.06.
Conversely, Archer-Daniels-Midland is sensitive to changes in global commodity prices. This is being seen right now as the low prices of corn and other commodities are negatively impacting the company’s profits.
With that said, Archer-Daniels-Midland has sufficient balance sheet strength to endure much worse commodity price recessions than we are seeing right now.
The company reported $748 million of cash at the end of the most recent quarter, and last year’s number was even better at $1.2 billion.
Source: Archer-Daniels-Midland First Quarter Earnings Presentation, slide 7
With that said, Archer-Daniels-Midland is still a cyclical company and is not likely to consistently grow earnings every year (though growth will be strong through full commodity cycles).
Valuation and expected total returns
Archer-Daniels-Midland’s future total returns will be composed of its current dividend yield, valuation changes, and increases in the company’s earnings-per-share.
Archer-Daniels-Midland currently pays a quarterly dividend of $0.32 per share which yields 3.0% on the company’s current stock price of $42.36.
For context, the S&P 500 has an average dividend yield of ~1.9% right now, which means that Archer-Daniels-Midland shareholders are receiving ~58% more dividend income than they would from investing in a broad basket of U.S. stocks.
This makes Archer-Daniels-Midland appealing for retirees or other investors seeking current portfolio income.
Valuation changes will likely be a negligible contributor to the company’s expected total returns.
As a cyclical company, Archer-Daniels-Midland likely experienced a profitability trough in fiscal 2016, which means that calculating a price-to-earnings ratio using 2016 earnings does not provide any insight from a valuation perspective (since earnings were temporarily depressed).
There are two alternatives to using 2016’s earnings.
One alternative is to use 2017’s expected earnings.
Archer-Daniels-Midland is expected to report adjusted earnings-per-share of $2.85 in fiscal 2017. The company’s current stock price of $42.36 is trading at a price-to-earnings ratio of 14.9 using 2017’s expected earnings.
The other alternative is to calculate a price-to-earnings ratio using the average of the past 3 year’s earnings. Archer-Daniels-Midland’s adjusted earnings-per-share during each of the past three fiscal years is shown below.
- 2014 adjusted earnings-per-share: $3.43
- 2015 adjusted earnings-per-share: $2.98
- 2016 adjusted earnings-per-share: $2.16
- Average (2014-2016): $2.86
Using the average of the past three years’ earnings gives adjusted earnings-per-share of $2.86, roughly in-line with 2017’s expected earnings. Thus, the price-to-earnings calculation gives the same figure of roughly 14.9 (mathematically, it is actually 14.8) using the average of the past 3 year’s earnings.
To determine whether the company is attractively valued right now, we can compare today’s valuation with its typical valuation. The following diagram compares Archer-Daniels-Midland’s valuation to its long-term historical average.
Source: Value Line
Archer-Daniels-Midland’s current price-to-earnings ratio of 14.9 is actually slightly above its average of 14.7 since the year 2001.
However, the difference is negligible, and given this conclusion I would expect that valuation changes are not likely to have a significant effect on this company’s future total returns.
The majority of Archer-Daniels-Midland’s total returns will come from earnings-per-share growth.
Historically, the company has grown its bottom line at a fantastic rate.
If the company hits Value Line’s estimate of $2.85 in adjusted EPS in fiscal 2017, it will have compounded its bottom line at a rate of 10.4% since 2001. This is shown below.
Source: Value Line
Looking ahead, I believe that an expectation of 6%-8% growth in earnings-per-share over full economic cycles is reasonable for this company.
The company’s future per-share earnings will be boosted by its considerable share repurchase program.
In the company’s first-quarter earnings release, it announced that it had repurchased $248 million of company stock in the three-month period, down from $296 million in the same period a year ago.
Source: Archer-Daniels-Midland First Quarter Earnings Presentation, slide 6
Approximately $250 million per quarter has a substantial effect on the share count of a company the size of Archer-Daniels-Midland, and meaningfully reduces the number of shares outstanding over time. Consider the following diagram for evidence of this.
Source: YCharts
This shareholder-friendly capital allocation will increase the intrinsic value of each shareholder’s fractional ownership and boost earnings-per-share over the long run.
To sum up, Archer-Daniels-Midland’s expected total returns will be composed of:
- Approximately 3% dividend yield.
- 6-8% EPS growth over full commodity cycles (boosted by share repurchases).
For expected total returns of 9-11% before the effect of any valuation changes (which will likely be minimal over the long term).
Final toughts
Archer-Daniels-Midland is a classic example of a high-quality business experiencing temporary troubles that do not impair its long-term growth prospects.
Although this security is trading at roughly fair value, buying high-quality businesses at or near fair value and holding them for the long run is a fantastic method to build long-term wealth.
Archer-Daniels-Midland is a buy based on its reasonable valuation, high dividend yield and shareholder-friendly capital allocation.
Disclosure: I am long ADM.
