Despite poor first-quarter results and a volatile business environment, Archer Daniels Midland Company (ADM) is undervalued enough to justify opening a long position. The manufacturer, processor and transporter of agricultural commodities has built up solid fundamentals (relatively) and is, in my view, unreasonably discounted to the competition. With management committed to returning free cash flow to shareholders and a low beta, ADM is an attractive defensive play. Risk-averse investors should consider going long ADM while shorting the competition in order to benefit from a differential. ADM is the largest producer in its field and, arguably, the most capable of weathering a challenging environment.
From a multiples perspective, ADM is very cheap. It trades at a respective 8.5x and 8.3x past and forward earnings while offering a dividend yield of 2.51%. Competitor Bunge Limited (BG) trades at a respective 9.3x and 8.7x past and forward earnings while offering a dividend yield of only 1.7%. Both companies have a reasonably clean balance sheet, although ADM is 450 basis points less leveraged when net debt is measured as a percent of market capitalization. Perhaps the most troubling aspect of both is their near 5% gross margins, which have come under even more pressure recently due to tight market supplies. While I believe neither company will be stellar winners in the stock market, I also believe they represent safe investments that have little downside after recent turmoil. Over the last six months, ADM and BG have lost nearly a quarter and a fifth, respectively, of market value.
At the first quarter earnings call, ADM's CEO, Pat Woertz, noted a disappointing quarter:
[W]e reported first quarter net earnings of $460 million or $0.68 per share on a fully diluted basis. Adjusted EPS, which excludes LIFO was $0.58 per share, 13% lower than last year's first quarter. Segment operating profit was $699 million. It was a difficult and challenging market environment this quarter. Margin conditions in our global Oilseed segment were generally weak, and net corn costs were high.
We, however, offset some of these pressures with first, good management of our commodity positions and also by capturing opportunities across our broad and diverse portfolio.
Looking ahead, we see the margin environment modestly improving, and we are optimistic about the long term. During the quarter, we focused on driving shareholder value by optimizing our existing asset base, expanding our core model and by buying back shares.
Positive highlights of the first quarter included achieving higher capital productivity and very strong returns in agricultural services. Strong grain merchandising in ag services was particularly refreshing in light of Bunge's weaker-than-expected grain handling - a sign that the company is positioned to outperform its competition. ADM also gained back access to the much-needed Black Sea exports. And in terms of capital allocation policy, management once again showed a commitment to being shareholder friendly by repurchasing 8.6M shares worth $240M in the first quarter alone. Bioproducts, sweeteners and starch additionally performed well.
All of the above was not enough, however, to offset underperformance elsewhere. Corn processing, Oilseeds processing, and Other were all very disappointing and made investors more hesitant about an entry. Ethanol prices are improving, but low oilseed margins and poor demand for meal is limiting the top-line. At the same time, much of this - if not all of this - has been factored into the stock price already and I do not believe the company may fall below its present multiples. It is more likely that, as trends improve, investors will point to ADM as the go-to supplier of agricultural commodities.
Consensus estimates for EPS are that it will decrease by 14.4% to $2.97 in 2012 and then increase by 12.9% and 5.7% in the following two years. Of the 13 revisions to estimates, the majority, 11, have gone down for a net change of (4.2%). Assuming a 11x multiple - higher than the current one, but justified due to stronger relative fundamentals - and a conservative 2013 EPS estimate of $3.25, the rough intrinsic value of the stock is $35.75. This implies a 28.1% margin of safety and justifies calling it a value play. Again, despite a rocky business environment, ADM is holding up well relatively and, as the largest producer in its field, is best capable of returning lost shareholder value during a recovery. Analysts currently rate ADM a "hold" and BG a "buy", but I think the reverse should be the case.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.