2023-11-28 16:33:12 ET
Summary
- Archer-Daniels-Midland's stock has underperformed in 2023, losing 21% of its market cap.
- Despite challenges in the nutrition division, ADM's flavors & colors portfolio, which accounts for half the division's profit, is flourishing.
- ADM's shareholder yield which measures not just dividends, but buyback momentum and the level of debt pay downs is underappreciated.
- Valuations are not pricey, and the stock is trading close to support.
Introduction
The stock of food processing and commodity trading player Archer-Daniels-Midland Company ( ADM ), hasn't been a rewarding play in 2023. At a time when the broader markets have delivered healthy returns within the high teens threshold, ADM has floundered, giving up 21% of its market cap.
ADM may be seemingly out of favor, but we believe the stock's fortunes could change soon enough. Here are a few reasons why we're more sanguine about the stock.
Not All Doom and Gloom In The Nutrition Division
One of the chief reasons why ADM hasn't done too well this year is on account of developments in the nutrition division. This is an important division for ADM, something which was flagged as a strategic priority through FY25. Management's FY25 target was to get this division to deliver operating profits of $1.25-$1.5bn by then, but based on the curtailed forecast for the year (FY23 operating profits will likely only be around $0.6bn, after 0.47bn on a 9m basis) there are some doubts if ADM can get there.
Also operating margins here over the last two years have been at the double-digit threshold, almost 2x that of the group operating margin. So clearly when this division is going through a slump and contributing a lower chunk to the overall sales mix, group margins tend to be adversely affected.
Clearly there have been some bumps along the road, but we don't believe this is a total washout. Within this segment you have four key cogs- a) flavors & colors, b) specialty ingredients, c) health & wellness, and d) animal nutrition.
What's key is that the Flavors & Colors group, which accounts for half of this division's operating profit, has been witnessing some resilience as ADM takes market share. In Q3, operating profits here have grown at an impressive 29% (FX adjusted), whilst on a YTD basis, it is also up at a healthy pace of 16%. Management believes the relatively shorter sales cycle of the products here should hold it in good stead through the rest of this year and beyond. Then within the animal nutrition sub-segment, ADM has chosen to take out some costs which should make the operations more efficient, whilst they have also noted an improvement in market volumes there. The health & wellness sub-segment has reportedly been performing in line with the market. In FY24, this sub-segment won't have to contend with the high-lapping effects of higher amino-acid margins. All in all, despite some challenges seen in the specialty ingredients portfolio (within this segment, texturants are still witnessing margin expansion), ADM management believes the nutrition segment will return to growth in FY24.
ADM's Shareholder Yield (Not Dividend Yield) Is Underappreciated
Besides the core story of ADM, the stock also attracts a lot of income-chasing investors, given its long track record of growing dividends (50 years on the trot). Also note that in the post-pandemic era, the pace of dividend growth has increased at a greater rate each year. In FY21 the annual dividend growth came in at 3% , followed by 8% the following year, and almost 13% this year!
Looking ahead, we think the dividend could continue to remain in a good place as management made the decision to increase its payout target from previous levels of 20-30% of earnings to 30-40% currently.
Before doling out dividends, you also need the company to maintain a healthy financial profile, and also get its working capital position in order (which in turn puts ADM in a better position to generate free cash flow). We feel ADM is now in a much better position when it comes to some leverage and working capital metrics.
In the pre-pandemic era, ADM's net debt to EBITDA was rather high at 3x, but note that in recent periods it has steadily declined, and at the start of this year it stood at 1.3x.
This year, ADM has managed to pay down a healthy chunk of debt, and its cash balance as of 9M-23 is also at its highest point in the pre-pandemic era at nearly $1.5bn . As a result, we've seen the net debt to EBITDA position drop even further to just 0.9x as of 9M-23.
Q3 Presentation
Now, given that ADM is involved in the agri-commodity supply chain, working capital dynamics here can be quite capricious from quarter to quarter, but yet still, do consider that for much of this year, they've been able to keep their cash conversion levels (a measure of how efficiently working capital is getting converted to cash) well below the 5-year average of 58 days.
Also take a look at how efficient ADM has become with managing its inventories, which is the biggest driver of working capital spend. Even though ADM's sales have been witnessing declining YoY growth for the last two quarters, the company is still doing a much better job of converting its inventory to sales, with the ratio now at 3-year highs.
Besides its dividend, ADM is also quite active in buying back its stock. Management's goal from FY21 was to spend around $5bn on buybacks, all through FY25 (as of 9M-23 they spent $1.1bn), and as things stand, it currently has 73.2m of shares that are still yet to be bought back as part of its existing share buyback program that will expire by December 2024. Crucially, on the Q3 call , ADM's CFO also suggested that they would be stepping up the pace of buybacks in Q4 as they feel the stock is undervalued.
So essentially you have a company that is paying down its debt, growing its dividends, and buying back shares at a greater pace. All these three sub-plots are effectively captured by the shareholder yield metric (do not mix this up with the dividend yield, which is just one cog of the shareholder yield). Note that at current price levels, ADM's shareholder yield of 7.3%, is almost twice as high as the historical level of 3.84%!
Closing Thoughts - Valuation and Technical Merits
ADM is not a particularly expensive stock to own at these levels. At the Q3 event, ADM management lifted their guidance for the FY, suggesting that the EPS would comfortably trump previous expectations of $7. Sell-side estimates currently point to an FY figure of $7.28 . That would translate to an inexpensive forward P/E of only 10x, a 13% discount relative to the stock's 5-year average.
Earlier in H1, we saw ADM's strength (relative to other consumer staple large caps) mean-revert to the mid-point of its long-term range, dampening the prospect of rotation. However, in recent months, that ratio has once again dropped lower by around 20%, opening up another window of opportunity to mean-revert.
Finally, if we switch our attention to ADM's own price imprints, we feel very enthused about the current risk-reward on offer. What's evident is that since the turn of 2022, the stock has chopped around within an approximate range of $70-$100. During this period, we've seen a couple of instances where it dropped down to the price support and recoiled from there. Last month we saw something similar happen, and after the bounce it looks like the stock is attempting to build a floor. Given the long runway to the $96-$100 resistance levels, and given how close it is to the $60-$70 support levels, we wouldn't be concerned about taking a long position at this juncture.
For further details see:
3 Reasons To Buy Archer-Daniels-Midland Stock