2023-10-24 23:48:49 ET
Summary
- Archer-Daniels-Midland benefits from strong growth in the biofuels industry, driven by government policies and sustainability goals.
- The company reported strong earnings in Q3, contributing to an outstanding year-to-date performance.
- ADM has a robust business model, a strong balance sheet, and has raised its earnings outlook for 2023. The dividend payout ratio is healthy.
Introduction
It's time to talk about one of my favorite agriculture stocks: Archer-Daniels-Midland ( ADM ). The company, which just reported its quarterly numbers, is doing extremely well. It benefits from multiple industry tailwinds, including strong secular growth in biofuels.
In this article, we'll discuss these developments, incorporate the just-released financial numbers, and assess the highly attractive risk/ward of what seems to be a significantly undervalued dividend opportunity in one of the most fascinating industries on the market.
So, let's get to it!
The Huge Biofuel Bull Case
Roughly a month ago, I wrote an article titled Why Archer-Daniels-Midland Is Poised For Significant Long-Term Gains. In that article, I highlighted the company's massive footprint in the agriculture industry.
Listed in 1924, the company has roughly 750 facilities and 42,000 employees that manage 440 crop procurement locations, allowing sellers and buyers in the agriculture industry to connect.
USD in Million | 2021 | Weight | 2022 | Weight |
---|---|---|---|---|
Ag Services and Oilseeds | 67,047 | 78.6 % | 79,563 | 78.3 % |
Carbohydrate Solutions | 11,110 | 13.0 % | 13,961 | 13.7 % |
Nutrition | 6,712 | 7.9 % | 7,636 | 7.5 % |
Other | 380 | 0.4 % | 396 | 0.4 % |
As shown in the overview, the company connects buyers and sellers and produces essential products for most food items sold in grocery stores.
This includes oilseeds and carbohydrate solutions, which account for the biggest part of the company's revenue.
In the United States, Archer-Daniels-Midland is the third-largest producer of ethanol, according to Statista .
With this in mind, earlier this week, major European bank ING wrote that this industry is in a very good position.
The bank believes that the biofuel industry in the United States is poised for substantial growth, driven by evolving supply and demand dynamics primarily shaped by government policies.
As one can imagine, this development is of particular importance to American farmers and biofuel producers, who are witnessing a surge in the demand for agricultural feedstocks in the biofuel sector.
As biofuels replace conventional fossil fuels in transportation and aviation, various biobased feedstocks, including agricultural crops and animal-derived products, are becoming critical for achieving sustainability goals and net-zero emissions by 2050.
Like many people, I am not a fan of using "food" to produce fuel, but in light of global energy policies, my opinion doesn't matter.
Furthermore, while corn-based ethanol initially gained momentum due to Renewable Fuel Standards ("RFS") and Low-Carbon Fuel Standards ("LCFS") in the mid-2000s, there is now a remarkable shift towards alternative feedstocks, driven by the growth of renewable diesel production.
Meanwhile, increased refining capacity has led to rising demand for animal fats and used cooking oil, as well as soybean and canola oil, further used in renewable diesel.
This shift has even led to renewable diesel production surpassing biodiesel production in 2023.
Adding to that, the new Inflation Reduction Act ("IRA") provides tax credits to the biofuels industry, extending existing credits for biodiesel and introducing new credits for sustainable aviation fuels.
In this light, during last year's JP Morgan All-Stars Conference, the company noted that it has benefited from robust demand in biofuels, with strong biodiesel margins, high demand for ethanol, and increased use of soybean oil in green diesel plants, which confirms the trends noticed by ING.
The company also mentioned the start-up of a new soybean crushing plant in North Dakota, which will add 1.5 million tons of capacity, focusing on low-carbon intensity feedstocks.
Furthermore, the company is actively working on decarbonization efforts, including carbon capture and sequestration expansions and agreements with partners like Warwick Carbon Solutions to provide low-carbon emissions power.
Earnings, Outlook & Dividends
In the third quarter, ADM reported adjusted earnings per share of $1.63, accompanied by an adjusted segment operating profit of $1.5 billion.
Notably, this quarter's results contributed to an outstanding year-to-date adjusted earnings per share of $5.62, making it the second-best EPS year in the first nine months!
Additionally, ADM's trailing 4-quarter average adjusted return on invested capital stood at 13.2%, which reflects the company's consistent strength in this environment.
ADM also acknowledged the dynamic nature of the global market, where opportunities and challenges coexist, which makes it challenging for traders and investors.
Consumer behavior trends vary across categories, impacting spending.
Issues also include geopolitical tensions, inflation, and fluctuating commodity supply and demand.
Despite these challenges, ADM continues to build on the momentum achieved year-to-date, with plans to surpass its 2023 expectations for the total company.
With that in mind, ADM's different business units showed robust performance in light of both tailwinds and headwinds.
- In Ag Services and Oilseeds, ADM leveraged its global presence to address the accelerating energy transition and strong demand for vegetable oil, ensuring a solid crush environment.
- In Carbohydrate Solutions, the company reported a record third quarter, driven by strong margins in starches, sweeteners, and flour, along with robust ethanol demand.
- In Nutrition, ADM's flavors continued to outpace the market, and the company executed its revenue opportunity pipeline. Productivity and cost management efforts in Animal Nutrition led to improved performance.
During its earnings call, the company emphasized that its competitive advantage lies in its broad and integrated business model that spans from farm to fork, which is something I already briefly mentioned.
In 2023, ADM capitalized on its extensive global origination network, partnering with farmers worldwide to offer traceable, sustainable crop sources for customers like PepsiCo ( PEP ), Nestle, and Carlsberg.
The company aims to enroll 4 million regenerative acres by 2025, equivalent to powering over 100,000 homes annually.
ADM is prepared to meet the demand for renewable fuel with initiatives like Spiritwood JV and Broadwind Energy project, contributing to lower carbon emissions and the need for "greener" fuels.
The company also has a robust balance sheet with an adjusted net debt-to-EBITDA leverage ratio of 0.9x, which provides them with financial flexibility to drive their long-term strategic agenda and return capital to shareholders.
It enjoys a credit rating of "A".
ADM has raised its 2023 earnings outlook and anticipates full-year EPS in excess of $7 per share.
Based on that context, Archer-Daniels-Midland currently pays a $0.45 per share per quarter dividend. This translates to $1.80 per year. It implies a 26% 2023E earnings payout ratio, which is extremely healthy.
The dividend yield is 2.5%.
Valuation
ADM is attractively valued. As we can see in the FAST Graphs chart below, the normalized P/E ratio is 14.6x, which has been a steady guide for the company for the past few decades.
Now, the company is trading at 9.5x earnings. That's the lowest valuation since the great financial crisis.
Even if earnings moderate in the next few years (analysts expect mild contraction after three stellar years), the stock is significantly undervalued.
A return to its normal valuation could technically result in 18% annual returns through 2025.
The current consensus price target is $97, which is 38% above the current price.
Hence, I stick to what I wrote in my prior article. I believe that ADM has a fair value between $100 and $110, which I expect the company to reach over the next three to four years.
Takeaway
Archer-Daniels-Midland is standing strong as a promising investment in the agriculture sector. The booming biofuel industry, supported by evolving government policies, presents a significant growth opportunity for ADM.
Their diversified business model has enabled them to weather market challenges and capitalize on global demand for sustainable crop sources.
ADM's strong financial performance, improved earnings outlook, and healthy dividend payout ratio make it an attractive investment. With its current undervaluation and a potential return to normal valuation, ADM could offer investors an 18% annual return through 2025.
Hence, I maintain my belief in ADM's fair value between $100 and $110, which I anticipate the company achieving in the next three to four years.
For further details see:
Archer-Daniels-Midland Hasn't Been This Attractive Since The Great Financial Crisis