The Market Undervalues Archer-Daniels-Midland

This industry leader has achieved more than four decades of dividend growth

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May 28, 2020
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With the S&P 500 reaching back above 3,000 for the first time since March, stock markets seem to have shrugged off the economic impact of Covid-19 for now. This means that it is once again starting to become difficult to find stocks at attractive valuations. However, there are still bargain opportunities out there.

Archer-Daniels-Midland Company (ADM, Financial) is one name that still trades at a discount to its historical valuation, offers an above-average dividend yield and has more than four decades of dividend growth under its belt. In this article, we will examine why I think the stock is a good investment.

Recent earnings and company background

Archer-Daniels-Midland is the largest publicly traded farmland product company in the U.S. The company is a leading processor of cereal grains, oilseeds, corn and wheat. It also manufactures protein meal, vegetable oil, flour, ethanol and other food and feed ingredients. In addition, Archer-Daniels-Midland buys, stores and transports a variety of agricultural commodities through its vast global network. The company trades with a market capitalization of nearly $22 billion as of the writing of this article.

The company reported its 2020 first quarter earnings results on April 29. Revenue declined 2.2% year-over-year to $15 billion, which was $737 million less than the analyst community had expected. On the other hand, earnings-per-share increased 39% to 64 cents, beating estimates by 8 cents.

The Agricultural Services & Oilseeds segment, which is the largest within the company and controls 10% of global volumes for the commodity, had operating profit growth of just 1.2%. Ag Services more than doubled year-over-year due to global trade, particularly the company’s South America business, which benefited from robust farmer selling in Brazil. Refined Products also showed growth due to higher margins in North American biodiesel and refined oils. Also aiding results were improved peanut shelling numbers. Wheat milling was strong. Operating profit climbed 75% for the Nutrition segment. Human Nutrition had growth in all areas of the business, including Flavors, Specialty Ingredients and Health & Wellness. North American demand was strong, especially for alternative proteins. Volumes and margins for feed additives in Animal Health continued to grow, and pet care sales were higher.

Offsetting this growth were results for the Crushing business, which declined from strong numbers in Q1 2019. Carbohydrates Solutions had a 29% decrease in operating profits. The Starches & Sweeteners business was negatively impacted by mark to market impact on forward sales of corn oil. This was a $50 million hit to this segment, though Archer-Daniels-Midland believes that this could reverse in the coming quarters. The Vantage Corn Processor business experienced lower ethanol margins as demand was weak.

Archer-Daniels-Midland didn’t report a disruption in its business due to the ongoing Covid-19 pandemic. As the largest company in an important sector, the company’s products remain in demand from consumers and other farm related businesses. As food is a necessity, Archer-Daniels-Midland’s business should remain steady even in a recession.

Archer-Daniels-Midland navigated the last recession quite well, with earnings-per-share growing nearly 8% during the financial crisis of 2007-2009. Helping matters is that the company ended the first quarter with more than $26 billion in current assets, including $4.7 billion in cash and equivalents, against total debt of $12.7 billion.

Dividend and valuation

After increasing its dividend by 2.9% for the March 5 payment, Archer-Daniels-Midland's dividend growth streak has now reached 45 consecutive years. According to the U.S. Dividend Champions, there are just 52 other companies in the market that match or exceed this. Archer-Daniels-Midland has increased its dividend by an average of:

  • 5.3% per year over the past three years.
  • 7.8% per year over the past five years.
  • 9.6% per year over the past 10 years.

Dividend growth is decelerating, but should be safe given Archer-Daniels-Midland’s payout ratio. The company is expected to pay out $1.44 per share in dividends in 2020. On average, analysts expect Archer-Daniels-Midland to record earnings per share of $2.95 this year, which gives the stock a payout ratio of 49%. This is above the 10-year average payout ratio, but not in a range that investors should fear a dividend cut.

Archer-Daniels-Midland offers a yield of 3.9% today, which is nearly double that of the average yield of the S&P 500. This would be the highest average yield for the stock since at least 2004, if averaged for an entire year. The average dividend yield over the last decade is 2.6%, which is 130 basis points below the current yield.

In addition to the above average yield, investors buying Archer-Daniels-Midland today would be acquiring shares of the company below its historical average valuation. Archer-Daniels-Midland earned $2.44 per share last year. Using the current share price of $39, the stock trades at a trailing price-earnings ratio of 16. Using estimates for 2020, shares of the company trade with a forward price-earnings ratio of 13.2. Archer-Daniels-Midland’s stock has had an annual average price-earnings as low as 9.5 and as high as 20.1 over the last 10 years. Today’s valuation is near the low end of this range. The average price-earnings ratio since 2010 is 15.

Given the company’s ability to withstand a recession, its yield and dividend growth history, I feel shares could trade closer to the historical price-earnings average. I estimate that a price-earnings range of 14 to 16 is an achievable valuation for Archer-Daniels-Midland. Based off 2020 estimates, this would mean a price range of $41 to $47. Investors could thus see as much as 20.5% upside from the recent price according to this estimate. Add in a yield that's almost 4% and investors could receive a solid total return from Archer-Daniels-Midland.

Final thoughts

As a global leader in farmland products, Archer-Daniels-Midland’s businesses remain in demand. The company did not report any negative impacts from the Covid-19 pandemic, and most segments showed growth from Q1 2019.

Archer-Daniels-Midland’s dividend is time and recession tested. Investors have received a dividend increase for more than four decades and shares offer an extremely high yield compared to the stock’s history and to that of the market itself.

Finally, Archer-Daniels-Midland’s valuation is low, too low in my opinion given the strength of its businesses and dividend track record. I thus rate shares of the company as a buy.

Author disclosure: the author has no position in any stock mentioned in this article.

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