Archer-Daniels-Midland: Solid Fundamentals, Bargain Price (NYSE:ADM)

Introduction

On December 27, I wrote an article titled “Ultrawide Moat, Great Valuation, Dividend Growth: Archer-Daniels-Midland Has It All.“

Although a three-month period is not a great measurement to check if a long-term thesis is working out, it needs to be said that Archer-Daniels-Midland Company (NYSE:ADM) shares have fallen 12% since then. During this period, the S&P 500 has returned 10%.

While ADM had been struggling with margins due to lower inflation, the main reason why its stock price is down is a lack of trust after some very unfavorable headlines started to pop up in January.

For example, as reported by Bloomberg’s commodity expert Javier Blas, the company ran into issues regarding an investigation into its accounting practices.

The company’s shares plunged 24% in a single day after the company let its CFO go due to an ongoing investigation.

In this case, investigations were aimed at its nutrition business, which is a relatively small business unit. However, it’s also a unit that is expected to drive future growth through strategic M&A and secular growth opportunities.

First, the company has disclosed that the investigation centers around its nutrition unit. In the first nine months of 2023, that segment delivered adjusted operating profits of $468 million, about 10% of the company’s total during the period. In 2022 and 2021, nutrition accounted for 11% and 15% of the operating profit, respectively. – Bloomberg

That said, there were other factors that contributed to a loss of investor confidence. For example, especially in light of challenges in other areas, the nutrition business is extremely important. It is also the result of a $3 billion acquisition of Wild Flavors. On top of that, in the past, ADM management has focused its bonus structure on the success of this unit.

Adding to that, in the 1990s, the company was accused of commodity price fixing. It pleaded guilty in 1996.

Please note that I’m not accusing ADM of any wrongdoing here. I am just stating some facts that have led to a substantial sell-off.

After all, legal troubles are one of the biggest reasons for investors to sell stock, as these issues are often tied to so much uncertainty.

Having said all of this, in this article, I’ll walk you through recent developments and explain why I remain upbeat about the company’s future.

So, let’s get to

An Important Update On Its Legal Situation

As one can imagine, the company started its earnings call by discussing the legal situation. According to the company, its internal investigation, led by its Audit Committee of the Board of Directors, resulted in the correction of certain intersegment sales that occurred between its Nutrition segment and its Ag Services and Oilseeds and Carbohydrate Solutions segments.

According to the company, these sales were “not recorded at amounts approximating market.” These adjustments also have no impact on its balance sheet, earnings statement, or cash flow statements.

Moreover, these adjustments did NOT impact its incentive plans, which is a very good sign, as it makes it very unlikely that the company may have changed some numbers in the past to achieve certain financial goals. So far, there’s zero evidence of that.

That said, the company’s internal investigation is nearly complete. It continues to work with the SEC.

While our internal investigation is substantially complete, we continue to cooperate with the Securities and Exchange Commission and the Department of Justice, and we hope you understand that we will not be taking questions related to these matters on the call today. We will provide updates on this matter in the future as appropriate. – ADM 4Q23 Earnings Call

Although I have no legal background, I believe the legal situation is turning out to be less bad than one might have anticipated. So far, there’s no evidence that the company fudged the numbers to make its business progress seem better than expected. This has brought back confidence, as ADM is trading 24% above its 52-week low.

The ADM Business Remains Strong

Moving beyond the legal situation, the company is doing quite well.

Last year, the company achieved the second-highest earnings in its history despite facing a challenging operating environment.

After all, a wide range of commodities, including agriculture and energy, were down compared to 2022.

For example, the chart below compares the ADM stock price (the black line) to the price of corn.

Although ADM doesn’t produce corn or related commodities, it has a business model that tends to perform better during periods of rising inflation, as this allows it to improve margins.

As ADM trades commodities and produces value-added products like ethanol and nutrients, it has razor-thin margins – often in the low-single-digit range.

On a side note, the chart below shows the relationship between the ADM stock price and the year-on-year inflation rate in the United States. While the long-term correlation is poor (ADM is a value-adding company instead of an economic indicator), the short-term correlation is very high.

With this in mind, the adjusted segment operating profit for 2023 came in at $6.2 billion. This is a 6% decrease compared to the previous year.

As we can see below, this decline was mainly driven by declines in operating profit in the Ag Services and Oilseeds (AS&O) and Nutrition segments.

However, other segments, including ADM Investor Services, saw significant increases in operating profit.

According to the company, this segment benefited from higher net interest income and higher insurance results on new program premiums.

Moreover, as we can see in the overview above, adjusted earnings per share in 2023 were $6.98, with improvements in pricing in Carbohydrate Solutions and Nutrition, as well as positive impacts from mark-to-market timing in AS&O.

These benefits were partially offsetting the impact of lower crush margins and higher manufacturing costs, which are typical headwinds in this environment of lower commodity prices but sticky input inflation.

Although these numbers are down compared to 2022, they are great numbers as 2022 was an unusually strong year. Especially in commodity-focused industries, it’s important to keep the bigger picture in mind.

Diving a bit deeper into AS&O, which accounts for roughly 80% of total revenues, the segment saw $4.1 billion in operating profit. That’s 8% lower compared to the record-breaking year 2022.

This decline was attributed to various factors, including reduced origination volume and margins in North America, lower results in Global Trade due to trade flow destabilization, and decreased crushing segment operating profit resulting from lower crush margins and higher manufacturing costs.

Moreover:

• In the Carbohydrate Solutions segment, the operating profit came in at $1.4 billion, which was 3% lower than the record achieved in 2022. This was mainly due to weaker volumes and lower corn co-product values.
• The Nutrition segment saw a 6% revenue decline compared to the prior year. Lower volumes were blamed on demand headwinds, destocking impacts, and operational challenges related to ERP systems integration.

So far, so good.

Now, the main question is what all of this means for shareholders.

(Shareholder) Value Creation

During its earnings call, the company explained some of its strategic objectives for 2025. For example, it highlighted achieving adjusted earnings per share at the top end of the objective range and maintaining ROIC above the 10% target.

In order to achieve its goals, investments have been made in multiple areas, including regenerative agriculture programs, renewable fuels partnerships, and facility expansions.

For 2024, the company has identified three priorities to create value:

• Managing the cycle.
• Nutritional recovery.
• Higher shareholder cash returns.

Moreover, destination marketing efforts are expected to drive growth in marketing volumes, while direct farmer buying initiatives aim for increased origination volumes.

The company is also increasingly focused on its nutritional recovery strategy, which includes strategic measures like hiring third-party experts to identify opportunities for efficiency improvements, M&A, and overall portfolio improvements.

With regard to shareholder distributions, the company’s Board authorized an additional $2 billion in share buybacks. This brings the total since 2022 to $6.4 billion. That’s 20% of its current market cap!

In fact, over the past ten years:

• ADM has hiked its dividend by 108%.
• It has bought back 22% of its shares, with a clear re-acceleration after 2021.

The company’s most recent dividend hike was 11.1% on January 26. Since then, it pays $0.50 per share per quarter. This translates to a yield of 3.2%.

This dividend is protected by a sub-30% payout ratio and an A-rated balance sheet with a 2024E net leverage ratio of just 1.8x EBITDA. The five-year dividend CAGR is 6.4%.

Although 3.2% isn’t a very juicy dividend, it has a low payout ratio and a lot of room for future growth – especially if the company is successful in growing margins.

After all, last year, the company generated roughly $94 billion in revenue. Every 0.01% operating margin improvement translates to more than $9 million in additional operating income!

Unfortunately, 2024 is not expected to be a great year, as the company expects adjusted EPS for 2024 to be in the $5.25-$6.25 range. This would represent an 18% year-over-year decline using the midpoint of that range.

As we can see in the chart below, analysts expect adjusted EPS to decline by 20% this year. After that, they expect a gradual improvement of 3% in 2025 and 2% in 2026.

While these numbers are subject to change, it seems that analysts are playing “wait and see,” which is very common in commodity-linked industries, as most analysts aren’t willing to incorporate a certain view on commodities into their thesis – I understand that.

That said, as most readers may know, I’m bullish on both energy and agriculture demand and expect a long-term (but volatile) uptrend in crude oil, natural gas, and various agricultural commodities, including corn, soybeans, and ethanol.

Hence, I expect ADM’s EPS to come in higher in the years ahead – at least compared to current expectations.

However, even based on current numbers, ADM is cheap. Using the data in the overview above again, the company trades at a blended P/E ratio of just 9.5x. This is way below its long-term normalized EPS multiple of 14.1x.

As such, based on the current environment, I believe ADM should not trade below $83, which is roughly 32% above the current price.

Needless to say, I remain bullish on the company and believe it is a good long-term investment for dividend investors seeking inflation protection.

Takeaway

Despite recent legal challenges and a tough operating environment, Archer-Daniels-Midland remains a compelling investment opportunity.

While legal uncertainties have impacted investor confidence, the company’s internal investigation has shown no evidence of financial manipulation.

Meanwhile, ADM’s diverse business model, strategic investments, and commitment to shareholder value creation, supported by substantial share buybacks and consistent dividend hikes, make it an attractive long-term investment.

Despite expected short-term earnings weakness, ADM’s long-term potential, especially in the context of potentially favorable industry trends, suggests a significant upside.

For dividend investors seeking inflation protection, ADM presents a promising opportunity for sustained growth and income.

Pros & Cons

Pros:

• Diverse Business Model: ADM’s diversified operations across commodities, renewable fuels, and value-added products provide resilience and growth potential.
• Shareholder Value Focus: The company has a commitment to shareholder returns through consistent dividend hikes and aggressive share buybacks.
• Strategic Investments: ADM’s strategic investments in regenerative agriculture, renewable fuels, and facility expansions position it well for future growth opportunities.
• Inflation Protection: With a history of performing well during periods of rising inflation, ADM offers a hedge against inflation for investors.

Cons:

• Legal Uncertainties: Recent legal challenges and ongoing investigations into accounting practices have created short-term uncertainty and impacted investor confidence.
• Earnings Volatility: The company faces earnings volatility due to fluctuating commodity prices and margin pressures in certain segments.
• Market Challenges: ADM operates in a competitive market with challenges such as trade flow destabilization and demand headwinds, particularly in its nutrition segment.