Archer Daniels Midland: Great Business Trading At A Fair Price

| About: Archer Daniels (ADM)
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Written by Nicholas McCullum on June 17th, 2017, for Sure Dividend

Dividend history matters. Here's why.

A long streak of steadily increases dividends is indicative of three important business qualities:

  1. The business is doing well.
  2. It has done well over many business cycles.
  3. 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

You can see the list of all 51 Dividend Aristocrats here.

Having 25+ 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 (NYSE:ADM) is one example of a Dividend Aristocrat that is having some troubles right now.

As a globalized agriculture company, it 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, the company 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.

Furthermore, Archer Daniels Midland ranked as a top 10 stock, according to The 8 Rules of Dividend Investing in the most recent edition of the Sure Dividend Newsletter.

This article will analyze the investment prospects of Archer Daniels Midland in detail.

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.

It has a very global business model - 47% of 2016 sales were generated outside of the United States.

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 5 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, it noted adjusted earnings per share 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 the company 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. It 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, it 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)

Though, 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 earnings per share.

It 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 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 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 years' earnings. Archer Daniels Midland's adjusted earnings per share during each of the past 3 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 3 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 years' 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 earnings per share 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 an expectation of 6-8% growth in earnings per share over full economic cycles is reasonable for this company. Its future per share earnings will be boosted by its considerable share repurchase program.

In Archer Daniels Midland's first-quarter earnings release, it announced that it had repurchased $248 million of company stock in the 3-month period, down from $296 million in the same period a year ago.

(Source: Archer Daniels Midland First-Quarter Earnings Presentation, slide 6)

~$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:

  • ~3% dividend yield
  • 6-8% earnings per share 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 Thoughts

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.