2023-09-15 16:47:50 ET
Summary
- Archer-Daniels-Midland is streamlining its operations to become less dependent on commodity prices and is accelerating dividend growth.
- The company is focusing on growth opportunities in renewable green diesel, Ag services, Carbohydrate Solutions, and the animal nutrition market.
- ADM's solid financials, diverse business model, and attractive valuation make it an interesting investment opportunity.
Introduction
One of the most fascinating companies in the global food supply chain is Archer-Daniels-Midland ( ADM ) , a company I have discussed a number of times in the past.
On July 12, I wrote an article titled Archer-Daniels-Midland: The Dividend King Is Turning Up The Heat.
The company, which has dividend king status thanks to more than 50 consecutive annual dividend hikes, isn't known for being a high-flying dividend growth stock.
Although this Chicago-based giant has returned more than 190% over the past ten years, almost this entire performance has come since the post-pandemic upswing. In general, the company is highly dependent on agriculture margins and periods of higher inflation to fuel earnings growth and stock price appreciation.
The good news is that the company is now in a more favorable environment and streamlining its operations to become less dependent on commodity prices.
It is also accelerating dividend growth and is a new member of Morgan Stanley's Dividend Equity Portfolio.
As reported by Seeking Alpha , the company added ADM in early August.
"ADM benefits from a strong balance sheet that allows it to allocate 30% of free cash flows towards organic growth initiatives and 70% for capital return or M&A ; this should support continued dividend hikes and share buybacks , leaving us favorable on its status as a “dividend aristocrat” (with >40 consecutive years of dividend hikes)," Skelly said.
In this article, we'll discuss these developments and explain why I agree with Morgan Stanley and believe that ADM is an improved dividend king with a lot of fuel left in the tank.
So, let's get to it!
Dividend Consistency & A Stellar Business Model
ADM shares currently pay $0.45 per share per quarter in dividends. This translates to $1.80 per year and a yield of 2.3%.
Over the past five years, the dividend has been hiked by 5.7% per year - on average, that is.
Seeking Alpha
This is hardly something to write home about.
However, there's more to it.
Founded in 1902 when George A. Archer and John W. Daniels started a linseed-crushing business, the company has a track record of more than 50 consecutive annual dividend hikes.
These dividends are protected by a payout ratio of just 22%, an A credit rating (one of the best in the world), and a bulletproof business model.
The company is a giant in the global agriculture supply chain, focused on ethanol production, oilseed production, trade, nutrition, and so much more.
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 % |
Listed since 1924, the company has roughly 750 facilities, 42,000 employees, and close to 440 crop procurement locations, providing farmers with a place to sell and buyers with a consistent inflow of agricultural goods.
Looking at the overview below, we see that the company connects a wide variety of buyers to sellers and produces products that are essential in more or less every food item we can buy at the grocery store.
Archer-Daniels-Midland
Based on this context, the company depends on a strong (inflationary) environment with favorable margins. After all, it has very slim margins.
Before the pandemic, less than $0.03 of every revenue dollar ended up as operating income. While low margins at this stage of the supply chain make sense, it's not what the company wants (obviously).
Over the past twelve months, the operating margin improved to 4.1%, which is a great result in this industry.
The problem is keeping margins high without simply raising prices. That would result in the loss of customers and add unnecessary inflation to a supply chain that already struggles with high inflation. In this case, I think I speak for everyone who has seen prices skyrocket at grocery stores since 2021.
ADM Is Improving Its Business
As Morgan Stanley already noted, the company is in a good spot to allocate a big chunk of money to grow its business.
That's exactly what the company is doing.
During the very recent Barclays Global Consumer Staples Conference, the company elaborated on its growth plans and the strong prospects in oilseeds, Ag services, Carbohydrate Solutions, and ethanol while acknowledging some challenges in nutrition.
ADM noted that the company has witnessed positive market conditions in recent years, but its primary objective is to grow earnings through productivity and innovation, offsetting market forces. This is essentially what I just mentioned: becoming less dependent on market cycles.
Achieving this would also make its stock price a bit smoother and less dependent on big surges during inflationary periods.
Having said that, the oilseeds business is experiencing significant structural changes, especially in terms of renewable green diesel demand, which is reinforcing its growth prospects.
As a result, the company anticipates a considerable increase in vegetable oil demand, which will support soy and soft seed crush margins.
According to independent research, the vegetable oil market is expected to grow by 7.5% per year through 2028. That's a big deal in an otherwise slow market.
Mordor Intelligence
The company also sees a general sense of optimism in the Ag Services sector, with expectations of substantial growth in destination marketing for agricultural commodities, providing higher margins.
Additionally, the Carbohydrate Solutions and ethanol sectors are showing better-than-expected developments, according to the company.
Moreover, although ADM's nutrition business has experienced a decline in growth rates, the company identified several challenges, including destocking, demand softness, and self-inflicted issues in demand fulfillment.
Archer-Daniels-Midland
- Plant-based meat, in particular, faced softness, but other areas, like alternative dairy and specialized nutrition, showed promising developments.
- The pet segment had rapid demand growth but faced capacity challenges in late 2022 and 2023, which are expected to be resolved by 2024.
The company remains optimistic about the future growth in its nutrition business.
Adding to that, the company is focusing on beating inflation while improving its struggling animal nutrition sales.
- ADM is taking strategic steps to improve its Animal Nutrition business. They have rationalized SKUs (focusing on fewer products that are better), production facilities, and employees and shifted focus to feed additives and ingredients. By leveraging its expertise and assets in Ag services and oilseeds, the company aims to capture growth opportunities in South American and Southeast Asian markets.
Using independent research again, we see that analysts expect the global animal nutrition market size to increase from less than $24 billion in 2023 to $43 billion in 2032.
Precedence Research
In its Carbohydrate Solutions segment, the company is focusing on low-volatility revenues.
For example, in 2014, the company generated between 60% and 70% of its profits from volatile products like ethanol (which is an energy commodity). Last year, that number was below 40%.
Note that this segment includes so many products used in a wide variety of goods further down the supply chain.
The Carbohydrate Solutions segment converts corn and wheat into products and ingredients used in the food and beverage industry including sweeteners, corn and wheat starches, syrup, glucose, wheat flour, and dextrose.
[...] Other Carbohydrate Solutions products include citric acids, which are used in various food and industrial products. - ADM 2022 10-K
Speaking of ethanol, the company is working on a strategy to capitalize on trends like decarbonization and renewable fuels.
During the aforementioned conference, the company emphasized its strong relationships with farmers and customers, especially in reducing scope three emissions.
Management mentioned investments in renewable diesel, solutions to SAF (Sustainable Aviation Fuel), and BioSolutions, and it sees sustainable growth opportunities in BioSolutions due to increasing demand for plant-based materials in various applications.
The Energy Information Administration sees a strong trend of renewable diesel production in the next few years.
Energy Information Administration
So, what about the valuation?
Valuation
ADM is very upbeat about its future. On a full-year basis, it expects to generate $7 in EPS. This would be the second-best result in its history.
The forward EV/EBITDA multiple is indicating one of the most favorable valuations since 2016 - despite its stellar stock price performance.
The company has also accelerated buybacks and hiked its dividend by 12.5% on January 26, which is well above its longer-term average. These are clear signs that the company trusts its turnaround.
This year, we've already done $1 billion of stock buybacks. With respect to dividends, we've increased dividends every year for the last 50-plus years. Our team is ambidextrous, is focused on not just near-term performance, but also on driving long-term earnings growth through a balanced focus on productivity and innovation. - ADM
The current consensus price target is $99, which is 24% above the current price.
In my prior article, I wrote that I believe in a fair value between $100 and $110. I stick to that.
While I expect that a potential recession can pressure ADM stock, I'm very bullish about its future, believing that we're now in a new era of elevated inflation and consistent agriculture tailwinds.
Hence, I also expect dividend growth to remain above average and investments in higher-margin products to bear fruit.
Takeaway
Archer-Daniels-Midland is shaping up to be an even stronger dividend king with promising growth prospects. While its dividend yield might not turn heads at 2.3%, the company's history of over 50 consecutive annual dividend increases is a testament to its stability and commitment to shareholders.
ADM's solid financials, with a low payout ratio and an excellent credit rating, provide further support for the dividend.
Furthermore, ADM's diverse business model within the global agriculture supply chain, including ethanol, oilseed production, nutrition, and more, positions it for long-term success.
The recent improvements in operating margins and strategic growth initiatives reflect a company becoming less reliant on market cycles and inflation spikes.
The future looks bright for ADM, with growth opportunities in renewable green diesel, Ag services, Carbohydrate Solutions, and more.
Analysts anticipate a substantial expansion in the animal nutrition market, and ADM is taking steps to capitalize on this trend.
With an attractive valuation and a consensus price target of $99, ADM offers an interesting investment opportunity. Despite potential economic uncertainties, ADM's continued commitment to dividend growth and strategic innovation make it a stock worth considering for the long term.
I remain bullish on ADM, expecting it to thrive in this new era of elevated inflation and consistent agriculture tailwinds.
For further details see:
Why Archer-Daniels-Midland Is Poised For Significant Long-Term Gains