2023-09-22 17:26:12 ET
Summary
- Archer-Daniels-Midland shares have dropped almost 20% from their all-time high, making them more attractive.
- ADM is a dividend aristocrat with a growing dividend and a payout ratio that suggests more decent increases in the future.
- The company operates in a cyclical industry so share prices might continue to fluctuate, but this could be a great moment for long-term investors to add to their position.
Archer-Daniels-Midland ( ADM ) has been a part of my portfolio for more than 5 years. During the past year, shares have lost almost 20% of their value. In this article, I will try to show that this drop in share price was not accompanied by deteriorating financials of the company. I am reiterating my buy rating because I believe ADM is a very attractive pick with regard to dividend growth, their future prospects are bright and the price looks right at the moment.
In December last year, I wrote an article about ADM, arguing that despite trading around an all-time high at almost $100, the company looked attractive. Since then, shares have lost almost 20% of their value, making my buy advice badly timed. To be fair, I also warned for the sometimes strong volatile cycles which shares of ADM have experienced in the past, so a drop of 20% should not spook long-term investors. But let us investigate whether this drop in share price has more to do with regular volatility or if the financial data of the company deteriorated.
Share price
As already mentioned in my brief introduction, Archer-Daniels-Midland's share price has dropped from an all-time high of almost $100 to a bit below $80, a drop of about 20%. This ended a very strong share appreciation cycle which started in 2020, during the pandemic.
As you can see in graph 1 below, ADM's price-to-earnings ratio is 10.6 now, which looks cheap. During the last 10 years, the company's PE ratio usually hovered around 15.
Graph 1: Archer-Daniels-Midland share price and price-to-earnings ratio during the last 10 years (Source: YCharts)
Of course, investors have to consider the cyclical nature of the food trading business, in which ADM is active. PE ratios are only strong metrics when earnings are predictable. In the case of ADM, earnings per share have fluctuated quite heavily for such a large company, as is illustrated in graph 2. Earnings are to some extent predictable, but not so much on a quarterly basis.
Graph 2: Quarterly earnings per share of Archer-Daniels-Midland during the last 10 years (Source: YCharts)
Dividend and payout
One of the reasons to be an investor in Archer-Daniels-Midland is the growing dividend. ADM is a dividend king, having increased its dividend every year for the last 50 years. Also, the company has paid dividends to their shareholders since almost 90 years.
This long history of dividend increases hasn't stopped the company from continuing to increase their dividend during the last couple of years, as can be seen in graph 3 below.
Graph 3: Archer-Daniels-Midland quarterly dividend payment and dividend yield during the last 10 years (Source: YCharts)
This year's dividend increase of 12.5% was one of its highest in its recent history. Even though Archer-Daniels-Midland's dividend yield does not look very high with 2.2%, I believe it is decent for a company that shows such a decent growth of dividend payments.
With regard to their payout ratio, all looks well. The company can be expected to easily afford more dividend increases during the coming years if their earnings do not come crashing down:
Graph 4: Archer-Daniels-Midland dividend payout ratio during the last 10 years (Source: YCharts)
I already mentioned that ADM operates in a relatively cyclical industry, and as such I believe it is prudent to keep the dividend payout ratio at a safe level, especially after quick increases in earnings. If earnings fluctuate, the company should still be able to easily afford its dividend payments without taking on more debt than necessary, and ADM seems to get this. Still, graph 4 seems to suggest that more decent dividend increases can be expected during the coming years.
Profits and margins
While graph 2 above clearly showed that quarterly earnings sometimes fluctuated heavily, the trailing 12 months earnings per share graph seems a bit less volatile, as can be seen in graph 5. Still, the cyclical nature of the business becomes apparent, and currently the company is experiencing a small drop in earnings per share.
Historically speaking, margins look very good at around the highest point during the last 10 years.
Graph 5: ADM share price, earnings per share and gross profit margin during the last 10 years (source: YCharts)
These margins have greatly contributed to the rise in earnings per share, since when looking at the revenue of ADM since 2010, it becomes clear that current revenue is not so much higher than it was between 2011-2014 (see graph 6 below).
Graph 6: ADM quarterly revenue and revenue per share since 2010 (source: YCharts)
The fact that EPS mostly rose because of margin improvements and not because of revenue increases highlights a potential risk for the company: if margins for Archer-Daniels-Midland would somehow drop (for whatever reason), the financial performance of the company would suffer greatly.
In the industry of ADM, margins are relatively thin (7.5% is their gross profit margin, their actual operating margin is around 4.15%). Let us compare ADM with one of their closest competitors Bunge ( BG ):
Graph 7: ADM and Bunge profit margins during the last 10 years (source: YCharts)
There are a couple of things which I find interesting:
- ADM's profit margins have been more or less consistently higher than Bunge's
- Profit margins of Bunge have fluctuated much more than the margins of ADM, which have been relatively stable but improving during the last decade.
For these reasons, I think it is justifiable to assume that ADM's profit margin will not suddenly drop in the near to medium term.
Buybacks
Next to their dividends, ADM has been rewarding shareholders by buying back its own shares. In the graph below, this is illustrated by the number of shares outstanding, which has dropped from more than 650M 10 years ago to 536M right now. Especially during the last year, there was a decent reduction in shares.
Graph 8: ADM number of shares outstanding during the last 10 years (source: YCharts)
A decreasing number of shares increases the value of a single share, since a single share represents a larger part of the company. This indirectly increases the earnings per share, since there are simply less shares to divide the earnings by. Also, it makes it easier for the company to pay a growing dividend, since they have to pay dividend on a lower number of shares.
Fluctuations, dividend increases and valuation
In my opinion, no article about ADM is complete without mentioning the cyclicality of their business. I already said it multiple times, but even though ADM is a dividend aristocrat, its share price can sometimes fluctuate heavily. This is illustrated in graph 9, where you can see the YTD total returns (so including dividend) for any day during the last 10 years.
Graph 9: ADM year-to-date total returns during the last 10 years (source: YCharts)
The stock has fluctuated from a YTD performance of around -35% (at the beginning of 2020 and the end of 2015) to a performance of more than +40% (2014 and last year). At this moment, the graph seems to be in a dip, meaning that shareholders who bought shares exactly 1 year ago have made a total loss of 13%. Of course, this does not mean that ADM's share price is certain to recover from this moment on, it might take much longer for this to happen. It only means that investors should have a strong stomach to deal with price fluctuations, no matter the moment. After my previous article, the share price dropped by 20% but I did not sell a single share.
The current dividend payout ratio of ADM, at 23%, makes it plausible that the company can continue its decent dividend increases during the coming years. If the company can raise their dividend by 10% for the next 5 years, this would lead to the following yield-on-cost if investors would buy their shares today:
Year | Yearly dividend | Yield on cost |
2023 | $1.80 | 2.3% |
2024 | $1.98 | 2.6% |
2025 | $2.18 | 2.8% |
2026 | $2.40 | 3.1% |
2027 | $2.64 | 3.4% |
2028 | $2.90 | 3.7% |
Table 1: Yearly dividend if ADM raises their dividend by 10% each year (source: calculations author)
In the table you can see that, although ADM's current yield on cost is currently not that high with 2.3%, after 5 years it rises to a more respectable level. Of course, high yield investors who need income right now still have little reason to invest in ADM, but for long term investors, ADM could be a nice addition to their portfolios. Also please note that the annual 10% dividend increases during the next 5 years are not unrealistic at all; ADM would already be able to afford the annual $2.90 per share easily using their current earnings per share of $7.50.
As we could see in graph 1, historically speaking, a price to earnings ratio of ADM of around 15 would be a normal ratio for Archer-Daniels-Midland. Just to be conservative and because earnings seem to have reached a temporary peak last year, I will subtract 10% from this PE ratio and end up at a current fair ratio of 13.5. This corresponds with a share price of $101.
Conclusion
Looking at the financial data of Archer-Daniels-Midland, I believe the company looks very solid and is a nice investment for long-term investors. A year ago, I gave the company a buy rating while they were trading around their all-time high, and I will reiterate this buy rating. Shares look even more attractively valued than a year ago, and using a conservative fair value PE ratio of 13.5, I believe ADM is worth slightly more than $100 per share.
I am convinced the company is poised to continue its long term growth streak on three different levels: revenue, earnings and dividend. Some of my new investment capital will be allocated to Archer-Daniels-Midland at these prices!
For further details see:
Archer-Daniels-Midland Looks Even More Attractive Now