Archer Daniels: Stuck Between Dividend Growth And Lack Of Consistent Results

Summary

• The company has been increasing its dividend payments for the past 42 years.
• Nonetheless, both its revenues and earnings are highly volatile.
• The need for diversification and additional growth vectors is crucial for the future.

Investment Thesis

Archer-Daniels Midland (NYSE:ADM) is a strong dividend grower with 42 consecutive payment increases. Management has proven over the years its capacity of managing cash flow in order to reward shareholders even during a down cycle. However, the stock price hasn’t generated much return over the past 10 years. The company is struggling to improve their revenues on a consistent basis. Demographics, emerging markets, along with stronger diversification may help ADM finding growth vectors for the next decade. ADM is currently fairly priced and offers an attractive dividend yield at over 3%. Let’s dig deeper into Archer-Daniels Midland.

Understanding the Business

ADM is more or less the “middleman” between farmers and food companies. It specializes in buying, processing and selling back commodities (mainly oilseeds and corn).

Source:ADM November 2016 investor presentation

Source:ADM November 2016 investor presentation

ADM benefits from its large size to generate economies of scale and the recent acquisition of Wild Flavor could become a great way to diversify from its core business.

Revenues

Source: Ycharts

As revenue stagnated between 2012 and 2014 and decreased to 2010 level afterwards, there is a feeling of emergency growing. Management is making an effort to diversify its core business model through acquisitions and investments. ADM is now active in the cocoa and chocolate business, lactic and acid business, South American fertilizer and Brazilian sugarcane ethanol. In 2014, ADM announced the acquisition of Switzerland-based Wild Flavor. The purpose was to use ADM processing capability and create synergy with Wild Flavor to create additional ingredients.

“Natural flavor and ingredients is one of the largest and fastest-growing consumer trends in both developed and emerging markets, and WILD Flavors is the world’s leading provider of natural flavor systems to the food and beverage industry,” ADM chairman and chief executive Patricia Woertz said in a statement. (source:Foxbusiness)

In addition to diversification, demographics and emerging markets could give a second push to ADM business. Global meat consumption is expected to rise on a continuous basis as the population grows. As soybean is widely used to feed animals, demand for such product will continue to increase as well.

Source:ADM November 2016 investor presentation

Earnings

Source: Ycharts

The price of commodities fluctuation along with the U.S. drought in 2012-2013 affected ADM earnings. Both revenues and earnings trends are hectic and it makes it difficult for an investor to determine where ADM will be in 10 years from now.

I understand the company sits on a solid reputation and has been popular among dividend investors due to its commitment to increase distribution each year. However, I don’t know how the company will continue to reward its shareholders if both revenues and earnings don’t get back on a more predictable trend.

Dividend Growth Perspective

ADM has been successfully increasing its dividend for the past 42 years making the company part of both the Dividend Aristocrats and Dividend Achievers. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers here.

Source: Ycharts

ADM has long been ignored by income seeking investors due to a relatively low yield. However, since 2016, the yield is now going between 2.75% and 3.7%. An investment in ADM is definitely not to see your capital growing fast. However, at a 3% yield, I can see the interest of purchasing some shares.

Source Ycharts

Beside the short episode where the cash payout ratio has been affected by the drought, we can say that both ratios are under control and management benefits from additional room for future dividend increase. In regards to its dividend perspectives, ADM meets my 7 dividend growth principles.

Potential Downsides

Such business model comes with various disadvantages. First, ADM is highly dependent on commodities price fluctuation and it doesn’t control its own production. Second, margins are razor thin as ADM has no pricing power on commodities that can be found everywhere. Third, the processing and transporting activities are capital intensive, drawing cash-flow away from the company.

Source: Ycharts

As you can see, ADM doesn’t have much room for mistakes year after year. I think it’s imperative for management to diversify their business model and find activities with stronger margin.

Valuation

At this point in the analysis, I’m a bit ambivalent as to whether I should add ADM to my watch list. I’m concerned by the hectic performance of the past decade, but management has proven its ability to provide shareholders with continuously increasing dividend year after year no matter which speed bumps the company incurred. The valuation of the company will determine its faith. Let’s take a look at the past 10 years PE ratio:

Source: Ycharts

Then again, it seems that even the market has a problem assessing the value of ADM as the multiples go from under 7 and as high as 27 over the past decade. It seems ADM has a solid base of investors ready to suffer from earnings fluctuation to keep the increasing dividend.

Speaking of which, I will use a double stage dividend discount model to determine the company’s fair value. I’ll be using a 10% discount rate as I don’t see enough competitive advantage to justify a lower rate. As management always succeed to increase its distribution for the past 42 years, I’ll keep a strong growth rate of 7% for the first 10 years and reduce it to 6.50% for the terminal rate.

Source:Dividend Toolkit Excel calculator spreadsheet

Using the DDM, it seems that ADM is trading at fair value.

Final Thought

In light of this analysis, I’m not convinced ADM should be part of my portfolio. The dividend perspectives are attractive, but the company has no control over many variables (commodity prices, margins, no pricing power, etc) to justify a strong buy in this case. If the company is able to diversify its business model through additional acquisitions, this could become an interesting pick.

Disclaimer: I do not hold ADM in my DividendStocksRock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.