2024-01-18 04:18:32 ET
Summary
- Archer-Daniels-Midland is a leading agricultural supply chain manager and processor with a broad portfolio of food and beverage ingredients.
- The company has strong long-term drivers, including steady growth in the end market and opportunities for inorganic expansion.
- It benefited a lot from the global supply chain disruptions, but due to normalization in end markets, the market has been pessimistic recently.
- I share the market's concerns about the near-term outlook and believe ADM stock is currently fairly valued. That's why it receives a "Hold" rating.
Investment Thesis
I have been screening for quality companies that have increased their profitability in the past few years while maintaining a healthy balance sheet and increasing their tangible book value. I believe this is a great combination for long-term success in investing.
While I mainly look at the last few years, I try to find long-term drivers as well. This ensures that even though the company may be going through tough times, demand will be increasing on average in the long term.
One of the more interesting companies that showed up on my screen was Archer-Daniels-Midland Company ( ADM ). I’ll refer to it as ADM from now on. In this article, we will go through what it does in detail, explain recent developments and long-term drivers, and finish with the valuation and recommendation.
While I think it is a great business with strong long-term drivers, it benefited a lot from the surge in the prices of its products, and I believe now it is the time for normalization. The market seems to think ADM’s profitability will drop in the short term due to this normalization, and I don’t disagree. That is why the stock gets a “Hold” rating.
Company Description
ADM is one of the world’s leading agricultural supply chain managers and processors. Through its connections, facilities, and supply chains, it provides a wide range of food products, oils, and other nutrition products for humans and animals. It has the broadest portfolio of food and beverage products in the industry.
The company holds a unique position in the agricultural value chain. Being founded in 1902, it grew to be a huge player literally feeding humans and animals all around the world. It has relationships with 210,000 farmers and more than 40,000 employees who work in 750 facilities. It operates in a significant number of countries worldwide, covering a vast majority of the global market.
Here are some numbers from the company’s most recent investor presentation to better understand how big it actually is.
Investor Presentation - December 2022
ADM operates through three segments.
Ag Services and Oilseeds
This is the biggest and arguably the most important business the company has. It generated more than 77% of the company’s revenue in Q3 2023 LTM, and it has consistently maintained this scale.
In this segment, ADM acquires agricultural raw materials from their sources (origination), then sells (merchandising), transports, and stores them. It also engages in the crushing and processing of oilseeds such as soybeans and other soft seeds into vegetable oils and protein meals.
At various stages of this process, the company sells oilseeds, crude vegetable oils, salad oils, and other food products to food, feed, energy, and industrial customers. For instance, ADM markets protein meals made from oilseeds to other companies, who then use these ingredients in producing feeds for farm animals and poultry. Additionally, it supplies crude vegetable oils that are derived from their crushing processes to companies that produce renewable green diesel.
The activities described above exemplify the broad range of outputs and end markets in this segment. This is also where scale matters. The company's extensive global footprint in sourcing, crushing, and processing enables it to access a diverse array of raw materials and serve a wide range of customers across various industries. The picture below shows that the company has most of its procurement footprint in the U.S., India, Brazil, and Paraguay; and most of its processing footprint in the U.S., Brazil, and Germany.
Investor Presentation - December 2022
Carbohydrate Solutions
This is the second big segment the company has. It generated around 15% of the company’s revenue in Q3 2023 LTM.
Carbohydrate Solutions focuses on processing corn and wheat through wet and dry milling methods. The company transforms these grains into various products and ingredients that are used in the food and beverage industry. The end products include sweeteners, corn and wheat starches, syrup, glucose, and wheat flour.
These products are in nearly every processed food you eat. In baked goods, soft drinks, condiments, snacks, and more…
According to the U.S. Department of Agriculture , the total U.S. per capita caloric sweetener deliveries for food and beverage use is relatively stable, with a slight decreasing trend. However, combined with 28% population growth in the same period, it is safe to conclude that the total demand for these products has been increasing.
USDA, Economic Research Service
Nutrition
As the third biggest segment, Nutrition generated around 7% of the company’s revenue in Q3 2023 LTM. This business manufactures and sells a wide range of ingredients and other products including flavors, colors, plant-based proteins, enzymes, edible beans, and botanical extracts. It also produces contract and private-label pet treats and foods.
These ingredients and products are sold to a diverse array of end markets including food and beverages, nutritional supplements, livestock feed, and pet food.
A summary of all these segments and ADM’s activities in the value chain, as well as the profitability of these segments, can be found below.
Investor Presentation - December 2022 S&P Capital IQ
Long-Term Drivers
As it can be seen from what the segments do, ADM feeds the world. It makes sure that the agricultural output is found, processed, and transported wherever necessary so they can be used in the making of food and beverages.
This end market demand is influenced by three key variables: the amount of food consumed per person, which is relatively stable year-over-year; the world population, where an increase implies greater food demand; and the price of its products and margins, contributing to short-term volatility.
A fourth variable affecting some of ADM’s products could be the per person sweetener and additive consumption. While there are talks about the rise of processed foods especially in the United States, as seen above in the Carbohydrate Solutions section, per capita caloric sweetener deliveries in the U.S. remain relatively flat.
These trends ensure steady growth in the end market, and ADM is further investing in its business for accelerated growth. The company “transformed its portfolio” with many small and big acquisitions. Additionally, it sold its chocolate and cocoa businesses in 2015 for more than $1.6 billion.
While population growth is a gradual trend, ADM actively focuses on acquisitions to expand its global reach and accelerate growth.
Investor Presentation - December 2022
Furthermore, even though interest rates are currently very high, the company has the ability to make more acquisitions thanks to its healthy balance sheet. The accompanying chart illustrates my projections of the company's available cash, representing its cash reserves prior to meeting all annual financial obligations.
According to my projections, it seems the company could potentially pursue acquisitions valued at over $1 billion.
In addition to being a leading ingredient provider for food and beverages, ADM also plays a crucial role in supplying materials for the production of bio-derived fuels like ethanol and biodiesel. With the global increase in energy consumption, the demand for renewable energy sources, such as those provided by ADM, is expected to rise. ( Source )
Recent Developments
Now, all the positive things aside, the stock's performance has not been consistent.
A comparison of ADM stock with the S&P 500 index ( SP500 ) reveals that the company significantly outperformed in 2022, with its stock price increasing by more than 40%. However, in 2023, the situation was quite the opposite, as ADM underperformed the market significantly.
There are a few reasons for this. It actually makes a lot of sense that the stock and the index returned nearly the same in the span of these two years.
The onset of 2022 was marked by significant developments in Eastern Europe, particularly the commencement of the Russia-Ukraine war. It caused massive issues for supply chains, especially regarding energy and agriculture . Ukraine is a major player in grain and oil-seed production. In fact, it is the world’s top producer of sunflower oil. Russia is similarly one of the largest producers of wheat and seed oil production.
The war meant a massive decline in agricultural output from these two countries. This was a huge disruption in food supply chains. Long-time buyers had to find new sellers, which benefited ADM . The company already had an established food supply chain all around the world. With the products from Eastern Europe unavailable, ADM could sell its products to more buyers at an elevated price.
However, the situation has since changed. Wheat prices are normalizing, and so are the prices of many agricultural products. The chart below shows the daily per bushel price of wheat, which is currently lower than it was at the start of the war.
We can see how similar the adjusted return on assets [ROA] chart of the business looks since 2017. While this is a relatively stable business with adjusted ROA typically ranging between 6% and 10%, rising prices helped it generate its all-time high profitability on assets.
The normalization of agricultural product prices is a key factor explaining the recent decline in ADM's stock value. The market expects prices to fall further, which would lead to lower margins and return on assets for ADM. Additionally, if the war ends soon and the supply from Ukraine reaches global waters more easily, the demand for ADM’s products might drop.
This seems to be the consensus among the market participants, and I find it hard to disagree with.
Valuation
ADM operates as a supply-chain intermediary, possessing significant capabilities in crushing and processing activities. This is a very asset-intensive business. To operate effectively, ADM requires various assets, including processing and storage facilities, railcars, trailers, ports, and other strategic locations.
That is why I think the price-to-book [P/B] is a great multiple to assess what the market thinks.
The company’s adjusted P/B has been hovering around 1x since 2008. This shows the asset-intensiveness of the business. The market believes that the company is worth as much as the value of its assets.
As you may have realized, there's a close correlation between the P/B chart and the previously shared ROA chart. This makes a lot of sense. The market realizes that the more efficiently a company uses its assets, the higher the value it can create.
The surge in P/B in 2022 is for a similar reason. The disruptions in the global food supply chains allowed the company to earn more compared to the assets they have, thanks to the elevation in prices. ADM's ROA significantly increased, rising above 14% in 2022 from below 10% in 2020, while its adjusted P/B multiple escalated to 1.8 in 2022, up from 1.2 in 2020.
Currently, the P/B multiple is down to 1.3. The market expects a normalization in return on assets, which as we have discussed before, makes sense. I anticipate that ADM's adjusted ROA will gradually revert to its historical average of around 8%, following an expected sharp decline in 2023.
I believe that market sentiment will stabilize during this normalization period, leading to minimal fluctuations in the adjusted P/B multiple. This means that to see an upside potential, we need to see growth. While long-term drivers ensure steady growth, I don’t see an extraordinary growth story here either. Considering these factors, it seems reasonable to conclude that the stock is currently fairly valued.
Upcoming Earnings
Although ADM has not yet announced the Q4 2023 earnings release date, it's worth noting that Q4 2022 earnings were disclosed on January 26, 2023, making it likely that the upcoming quarterly results will follow a similar schedule.
It will be crucial to examine year-over-year sales changes in each segment to assess whether demand is returning to normalcy. Furthermore, the company reports processed volumes by commodity each quarter, which can offer valuable insights, particularly given the recent price volatility.
If the normalization thesis proves accurate, it would naturally result in a substantial year-over-year decline in both sales and processed volumes.
Finally, in the Q3 2023 call, the management stated that they expect margins to remain healthy, especially in the crushing business. Any noticeable underperformance here could serve as a potential catalyst prompting market reactions that may lead to a decline in the stock's value.
Conclusion
Archer-Daniels-Midland is an amazing business. Operating one of the largest and most established food supply chains globally, with extensive connections, the company has demonstrated its strong positioning to capitalize on supply chain disruptions.
I believe the company is poised for steady growth, bolstered by solid long-term drivers like population growth and opportunities for inorganic expansion, such as strategic acquisitions.
However, with the ongoing normalization in food supply chains and prices, it's probable that the company will experience corresponding normalizations in its margins and earnings soon. This puts a lot of pressure on the stock price but seems justified. Given these factors, I assign a “Hold” rating to the stock, anticipating a more favorable entry point in the future.
For further details see:
Archer-Daniels-Midland: Great Company But Greater Short-Term Headwinds