2023-08-15 11:50:19 ET
Summary
- Archer Daniels Midland is a large-cap, dividend-King that presents a buying opportunity due to a recent pullback.
- The company is a global agricultural supply chain manager and processor, with a wide portfolio of food and beverage solutions.
- Archer Daniels Midland has a low dividend payout ratio, strong performance, and a high return on invested capital, making it an attractive investment option.
Headline
Stumbling across a PEG ratio deal that I like is hard. Even harder these days is finding one that is also a large cap and a dividend payer. As we enter a mini-bull that may or may not last, values, in general, are in short supply. Archer Daniels Midland ( ADM ) , is a stock I have owned in small amounts for quite some time, but never oversized a bet. It was a holding that existed in my portfolio due to it registering on the Magic Formula screener at some time in the past whilst I was alpha indexing higher ROIC companies using Joel Greenblatt's screener.
Archer Daniels is one of those, who could have been in the Dow Industrial Average 30 backbones of commerce. Producing Ag and oilseeds, carbohydrate additives and starches, animal and human nutrition products as well as biofuels, this is as widely diversified as you get. Archer Daniels is a buy. The company's recent, demonstrable strong performance combined with Dividend King status and a low payout ratio of earnings and cash flow pertaining to that dividend check all my boxes.
The chart
Archer Daniels Midland is not one of those wrecked stocks I often like to write about. Only about 12.5% off the high, it's simply a high-quality company that presents a nice opportunity due to the pullback. This is one of those lock it up in the family trust stocks that you have confidence in. One that should be around for a few more generations, paying a growing dividend along the way.
What they do and the story
Archer Daniels Investor Relations
The Company is an indispensable global agricultural supply chain manager and processor; a premier human and animal nutrition provider; a trailblazer in groundbreaking solutions to support healthier living; an industry-leading innovator in replacing petroleum-based products; and a leader in sustainability. -Archer Daniels Midland 10K
In short, Archer Daniels Midland is a producer of nearly every type of starch or oil-based food ingredient. They boast to have the widest portfolio of food and beverage solutions and are ramping up alternative meat/dairy and protein solutions. Pea protein is a big focus of the recent presentations to support the alt-meat supply chain. Biofuels and a futures commodity trading platform round out the businesses, of which, I'm probably leaving out a few.
This is a keeper blue chip Dividend King, as Charlie Munger would put it, let it be a cornerstone of "SONYA" style investing:
"Sit on your ass investing. You're paying less to brokers, you're listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum."- The Tao of Charlie Munger pg. 24
Valuation model
The Peter Lynch PEG ratio model I like to use is what was laid out in One Up on Wall Street . Find the trailing CAGR percentage, do not go over 25% growth assumptions, and add the dividend to the final multiple. So EPS growth of 10% and a 2% dividend would create a 12 multiple times the current year EPS multiple.
PEG ratio with a dividend kicker for Archer-Daniels-Midland
- Basic EPS 2018 $3.21/share
- Basic EPS TTM $7.72/share
- Trailing 5 year CAGR of 19.18%
- Plus dividend kicker of 2.12% equals a total multiple of 21.3
- 2023 EPS estimate of $7.3 X 21.3 = $155.49
Seeking Alpha
While Archer Daniels has been no slouch in this current run-up to where it stands, even cutting growth in half going forward leaves you with a fairly valued Dividend King. There are almost no fairly valued dividend Kings and almost all tend to trade at some sort of premium unless they're in financial duress. Archer Daniels is not in duress. Certainly very few trade at a PEG ratio below 1.
ROIC
Since this originally ended up in my portfolio due to it being a Magic Formula stock, let's see what kind of Return on Invested Capital Archer Daniels Midland is currently producing.
Archer Daniels Midland Investor Relations
All data provided by Archer Daniels Midland, numbers in millions
Nopat (net operating income after taxes)/total LT + ST borrowings + total equity
- Nopat=EBIT X (1- tax rate) +adjustments = 4,659
- TTM total equity= 24,520
- TTM Long term debt + short term borrowings = 9,280
- NOPAT/ Invested Capital= 4,659/ (24,520+9,280)= 13.7% ROIC
13.7% is great for a low-margin high volume business. The fact that the company has also been trading at a discount to the broader market earnings yield, both GAAP and Non-GAAP which makes up the other half of the Magic Formula equation is another element that got the stock to screen well. Let's see what share count has been doing to establish the current EPS growth rate.
Commodities trends
Being that Archer Daniels relies on Ag commodities as the underlying feedstock for their products to sell to both human and animal food producers and energy additives manufacturers, the cost of goods sold is very relevant.
Seeking Alpha
The spike in commodity prices in June 2021 has receded a bit, not much, but this is a low-margin business after all. Small increments can mean a lot when you have high volumes.
Using the Teucrium soybean and corn ETFs, ( SOYB ) and ( CORN ) as a proxy for corn and soybean trends, we can also see a recent pullback. These are the two most important feedstocks for Archer Daniels operations.
Balance sheet trends
The answer to the steady EPS growth without huge upward trajectories in net income is partly a product of share buybacks. Great use of capital when there's no better investment than yourself.
Comparing current assets to long-term debt, the company is high up on the list of companies you will find where current assets are far greater than long term debt.
2023 Company outlook
Archer Daniels investor relations
Archer Daniels Investor Relations
Adjusted operating profit has remained flat over the trailing 5 quarters, but is down yoy from last year's Q2. Ag services and oilseeds continue to dominate the Archer Daniels business. A deal inked with China in 2022 could enhance sales volume after the recent August flooding has wreaked havoc on a lot of domestic Chinese crops.
Liaogang Nisun Supply Chain Management Co. Ltd., a Fintech Digital Technology Co. Ltd. subsidiary and controlled affiliate of Nisun International Enterprise Development Group Co. Ltd., has signed a strategic cooperative with ADM Management Co. Ltd., a Shanghai, China-based subsidiary of Archer Daniels Midland Co.
Nisun focuses on linking key stages and stakeholders of the agriculture supply chain from agricultural research and development, production and processing to storage, transportation, sales and marketing, consumption and service.
Chicago, Illinois, US-based ADM is one of the largest oilseed, corn and wheat processing companies in the world. ADM Shanghai, founded in July 2012, is the regional headquarters of ADM in China, responsible for managing all ADM Group factories in China.
Under this agreement, the two parties will work together on developing supply chain transportation services. Nisun will help ADM efficiently transport products from its factories to designated locations across China.
This is a story to be watched. There are still several submerged cities in Northeast China.
Margin trends
Seeking Alpha
Gross margins for Archer Daniels are about 7.5 % and have ratcheted up in the past few years. Net margins are more in the realm of 4%.
The dividend and free cash flow
Seeking Alpha
With $6.54 TTM in free cash flow per share, the forward $1.80 dividend is only a payout ratio of free cash flow in the neighborhood of 27%!
Just looking at earnings alone as a metric, a paltry payout ratio of 21.8% leaves a high margin of safety for dividend coverage with lots of room for future growth.
Total return on DRIP
Considering the company has been growing EPS for the past 5 years at 19%, we usually assume that share price appreciation would follow. In any conservative model, we want to put our growth rate as low as possible. That being said, a 9% upside per year combined with our 2.12% dividend growing at 5.35% seem like very conservative assumptions for inputs. Let's see the 10-year total return assumption:
Tip Ranks
Again, I believe these are fairly conservative assumptions at this entry point being that it's trading at almost a .5 PEG ratio. Additionally, Archer Daniels has ample space to move the dividend up higher than 5.3% per year.
Catalysts
A coiled spring?
Whale Wisdom
An interesting fund to follow is Jim Simons' Renaissance Technologies 13F . The famous mathematician has put together what has arguably been the most successful large hedge fund of all time. Nobody knows the stock selection criteria that the fund's algorithmic trading identifies, but we can assume that new buys are those that the company assumes will appreciate in the next 1-2 quarters. This is a fund with a large turnover and large fees. They need to sell to cover their enormous fees which are up to 44% of net profits. Archer Daniels comes in at #12 on the list of new buys with a $105 million bet.
Some other interesting names on the list that I have recently bought are 3M ( MMM ) and Dollar General ( DG ). This is just my opinion on how to look at the list. I hope to study Renaissance Technologies in a code cracking attempt for a future article.
Long term ROIC
Archer Daniels MRQ presentation
The goal of achieving at least a 10% long-term ROIC would be amazing for the business and a trajectory that would continue to beat the previous norms. Since the company is trading for about 11 X GAAP or a 9% earnings yield, that means we can buy the company right now for almost the same amount as the projected long term ROIC.
Increases in oil prices
Google Finance
Higher oil prices typically mean higher demand for ethanol. If the price of crude oil continues its' unexpected rise, ethanol sales could have a buoy for a while. With China also now fully out of Covid, we have yet to see the demand pick up enough from Chinese travel. It will happen, just a matter of when.
Risks
CFRA and Morningstar are both putting a hold rating on the stock. The reasoning is that they believe earnings peaked in 2022. If Archer Daniels can hit their ROIC mark of 10% long term and we are buying it currently for an 9% earnings yield, I would assume my conservative total return assumptions would be par for the course.
Recent flooding in China could affect the soy and corn markets. Soybean meal import demand for feedstock could rise in future quarters as well as soy and corn in general. How this will affect the cost of goods sold versus the price these Ag product producers can charge for their products remains to be seen.
Known as China’s granary, the three north eastern most provinces – Heilongjiang, Jilin and Liaoning – produce more than one fifth of the country’s grain output, thanks to the region’s fertile black earth. Major crops produced there include soybeans, corn and rice.
The floods, which have not been well covered by the media, were some of the worst in Chinese history. They broke a 140-year rainfall record in Beijing. Furthermore from the CNN article :
Last week, the Ministry of Agriculture and Rural Affairs warned that the heavy rainstorms brought by Typhoon Khanun and Typhoon Doksuri were expected to cause “severe impact” on China’s agricultural production.
If you believe the agribusiness sector is about to have a pullback, then this stock might not be right for you. I, however, find it hard to find PEG 1 or lower stocks in industry-leading blue chips. While the industry as a whole is tracking this valuation, you have the chance here to grab the largest cap dividend king of the bunch. If you believe in the 10% ROIC projections by Archer Daniels, then this stock is certainly on the buy board.
For further details see:
Archer Daniels Midland Is A Major Cheap Dividend King