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Archer-Daniels-Midland: Dividend Appeal Goes Beyond Short-Term Pain

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About: Archer-Daniels-Midland Company (ADM)
by: RadaEcoWatch
RadaEcoWatch
Portfolio strategy, macro, long/short equity, ETF investing
Summary

Archer-Daniels-Midland is one of the world’s leading producers of food and beverage ingredients, and other products made from a variety of agricultural products.

The Company is attractive for long-term investor for its ability to pay a quarterly dividend for 352 consecutive quarters.

In 2019, results have been negatively impacted by temporaty factors as the African Swine Fever (ASF) crisis in China.

We expect an improvement in 2020 for the latest signs that China is overcoming the ASF crisis.

We value ADM $50.7 per share using a DCF model. It represents a 15% upside potential from Friday’s close at $43.95.

Investment case

Archer-Daniels-Midland (ADM) is one of the world’s leading producers of food and beverage ingredients, and other products made from a variety of agricultural products. The food industry could benefit over the next few years of demographic trend and rising consumption of food, especially in the emerging markets.

The company is attractive for long-term investor for its ability to pay a quarterly dividend for 352 consecutive quarters. It is also a member of the aristocratic index, having increased the dividend for more the 40 years consecutively.

We think that the company will be able to generate enough cash over the next few years to finance the recently announced buy-back program (100m shares over the next 5 years) and increase the dividend. According to our estimates, the annual dividend should rise from $1.34/share in 2019 (a 3.0% dividend yield at current stock price) to $1.8 in 2023. At current stock price it would be a 4.0% dividend yield. In our base scenario, we assume that the company could gradually lower the payout ratio from 69% in 2019 to 46% in 2023. A 60% payout ratio would be in line with a $2.5/share dividend and a 5.4% dividend yield.

In 2019, results have been impacted by the negative trend in Agriculture Services, Oilseeds and Carbohydrate Solutions while Nutrion segment reported a 14% increase in Operating profits. We expect an improvement in 2020 as the company could benefit from lower tension in the Chinese market due to improvement of the African Swine Fear (ASF) crisis, less negative weather conditions in North America and a stabilization of ethanol margins. Finally, Readiness related projects could have a positive impact on marginality, with a cumulative impact of $1.2bn by the end of 2020.

We value ADM $50.7 per share using a DCF model. It represents a 15% upside potential from Friday’s close at $43.95. We think that to rise above that level, the ADM must reach the company’s long-term target of a 10% ROIC, up from 6.5% during the latest 4 quarters.

ADM: ROIC and WACC(source: company's presentation)

Why Archer-Daniels-Midland is attractive

Archer-Daniels-Midland is one of the world’s leading producers of food and beverage ingredients, and other products made from a variety of agricultural products.

In our view, investors should look to the company for two reasons:

  1. As the world population grows, the company plays a pivotal role in meeting the needs for quality foods, feed ingredients for livestock, alternative fuels, and environmentally friendly alternatives to traditional chemicals. World population is expected to grow from $7,7 billion in 2019 to $9,7 billion in 2050;
  2. The impressive track record of shareholders remuneration. It has paid a dividend for 352 consecutive quarters (88 years) and it has increased it every year for more than 40 consecutive years. The stock is a member of the S&P aristocratic index – meaning that it has raised its dividend every year for at least 25 years – since its inception.

AMD has underperformed the S&P500 over the last 3 years (+42% for the S&P500, 0% for AMD) as investors focused on growth stocks and ignored value stocks. In this scenario, the stock could be a value proposition in case of an inversion of the recent equity market upward trend. Moreover, the stock price could benefit of purchases from investors looking for a substitute of government bonds due to the attractive dividend yield and the long-term ability to raise it over the years.

ADM vs S&P500

Short-term outlook: ASF in China weighed on company results but the outlook is improving

AMD 2019 results have been negatively impacted by ASF in China and negative weather condition in USA. During the first 9 months of 2019, AMD posted mixed results. Revenue were almost unchanged at $48.327bn but operating profit declined 37% to $1.092bn and net income by 41% to $875m.

However, Q3 results showed a marginal improvement: revenue increased 5.9% from the same quarter last year to $16.7bn, led by the nutrition segment (+58.0%) for increased demand for plant-based protein. Operating profit fell 14% for the quarter, while adjusted EPS declined 16% year-over-year.

ADM Q3 and 9M results(source: company's 9M results press release)

The company will release financial results for the fourth quarter of 2019 after the market closes on Wednesday, Jan. 29, 2020, with a conference call planned for the following day.

We expect that the company could benefit of the first sign of recovery of ASF situation in China. The Global Times (China's hog production recovers in December 2019: ministry) reported that, according to Yu Kangzhen, deputy head of the Ministry of Agriculture and Rural Affairs, China's hog production saw recovery in December 2019, with the percentage of pigs available for slaughter up 14.1% from November. December marked China's first rise in hog production since August 2019.

The steady rise of China's hog production capacity is also reflected in the country's stock of breeding sows, which rose 2.2% in December, a third consecutive monthly rise, Yu noted during a press conference.

Medium-term outlook: looking beyond short term pain

We have a favorable long-term view of the company’s growth prospects. Despite a tough short-term environment, the company continued to invest to increase long-term potential growth, adding to a huge global network that includes approximately 450 crop procurement locations, more than 330 food and feed ingredient manufacturing facilities, and over 60 innovation centers.

The company recently completed the acquisition of the leading European citrus flavor provider. This will help position the company as a global leader in the growing natural citrus ingredients market. ADM also announced the opening of an upgraded nutrition flavor research and customer center in Beijing. This will help expand and enhance its capabilities in Asia, which is home to many emerging markets such as China and India.

ADM M&A operations

Of the four business segments in which ADM’s operations are organized (Origination, Oilseeds, Carbohydrate Solutions, and Nutrition), we think that Nutrition is the most promising one. The Nutrition segment operates in the manufacturing, sale, and distribution of specialty products including natural flavor ingredients, flavor systems, natural colors, proteins, emulsifiers, soluble fiber, polyols, hydrocolloids, natural health and nutrition products, and other specialty food and feed ingredients. The segment could benefit of the long-term trend of Specialty ingredients market (worth $50bn and growing at 5-6% CAGR) and of Animal nutrition market (worth $700bn and growing at 3% CAGR).

Valuation

We valued ADM using a DCF based on the following assumptions:

  1. Ebit growing at 6.2% CAGR in the period 2018/2023. As operations normalize in China and USA, we expect the company to see a rebound of revenue growth from 2020 (2.4% CAGR in 2018-2023). Higher revenue growth will have the effect to increase marginality;
  2. Capex of $800m per year in the period 2018-2023, in line with Company’s goal to align Capex and Amortization;
  3. Working capital at 12.7% of revenue, in line with company’s long-term average;
  4. WACC of 6.75%, in line with latest AMD calculation;
  5. Perpetual growth rate of 1.5%.

We derive a $50.7 per share target price. It represents a 15% upside potential from Friday’s close at $43.95. At our target price, the stock would trade at 17.2x 2020 P/E and 15.2x 2021 P/E.

ADM P&LADM DCF model

The company is now trading at 16.9x ‘19 P/E ratio. It is above both the last 5-year (15.2x) and 10-year (14.6x) average. However, according to our estimate and Friday’s ADM close, the P/E ratio should decline to 14.9x in 2020, slightly below the 5-year average and above the 10-year average.

ADM P/E trend

Conclusion

Archer-Daniels-Midland is a must-have stock for long-term investors with a focus on dividends. Having increased the dividend over the last 40 years, we expect the company to continue increasing it over the next few years: the dividend could rise from $1.34 in 2019 to $1.8 in 2023. We expect that the improvement of ASF crisis in China could lower investors’ short-term concerns on company’s perspective. We see the recent decline of the stock as a BUY opportunity, with an $50.7/share target price.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ADM over 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.