This title isn’t clickbait but genuine concern. In August, I wrote my most recent Archer-Daniels-Midland (ADM) article, highlighting the agriculture bull case and the company’s abilities to capitalize on it. Since then, the stock has added 25%, which is not just a lot in general, but especially given that ADM is a large-cap with usually lower long-term returns. In this article, I will update my bull case and explain why ADM investors are in such a great place given what’s happening in the world and the company itself and why I’m waiting for weakness before recommending new stock purchases. So, bear with me!
Agriculture Is Red-Hot
I’ve been on top of the agriculture trade since early 2020 when I did various research projects for clients. Agriculture was our “big thing” since the pandemic crash of 2020. Since then, it has evolved better than expected. It started rather simple as we expected demand to come back after lockdowns fueled by high export demand from countries like China. Then, bad weather conditions in 2021 fueled the bull market further followed by high energy prices in the second half of 2021 that caused a steep surge in fertilizer prices. Hence, it is expected that crop yields are worse in 2022.
Now, things are getting worse due to the war in Ukraine. On February 1, I published an article mentioning the significance of Ukraine in the global agriculture supply chain.
Right now, the agriculture bull case is going so fast that I’m not rooting for it anymore, even though it was “my thing”. It’s becoming downright serious with high food inflation in developed nations and risks of food insecurity in developing nations that depend on food imports.
In the US, for example, food inflation is close to 7.5%, a multi-decade high with devastating effects on poorer households who are on a tight budget anyway.
The Norwegian fertilizer producer Yara commented on these developments, saying that:
“One potential consequence is that only the most privileged part of the world population gets access to enough food,” Yara said, adding that while high prices may have a short-term positive impact on profit, they would mean an unsustainable food system, leading to starvation and conflict in the long term.
As a result, agriculture stocks are flying. One of them is Archer-Daniels-Midland. The stock is shining again with a 16% year-to-date performance excluding dividends. Meanwhile, the S&P 500 return is minus 8%.
ADM benefits from its dominant position in the global food supply chain. Hence, its shareholders benefit as well.
This Crisis Unlocks Value
To quote from my last article – with updated numbers:
ADM is an extremely complex company engaged in all key aspects of the global food supply chain. This Chicago-based company was founded in 1902 and employs close to 40,000 employees. With a market cap of roughly $42.4 billion, it’s the largest company in the farm products industry.
ADM operates a number of business segments.
- Ag Services & Oilseeds (77% of 2020 sales)
- Carbohydrate Solutions (13%)
- Nutrition (9%)
- Other (Negligible)
Ag services and oilseeds include operations that take place at the start of the food supply chain. These operations are related to the origination, merchandising, transportation, and storage of agricultural raw materials, and the crushing and further processing of oilseeds (soybeans, cottonseed, sunflower seed, canola, rapeseed, etc.). These products are used food, feed, energy, and industrial feedstock. This includes renewable diesel and more or less everything that comes to mind when thinking of food.
On top of that, the company owns the largest ethanol plants in the United States. According to the data below, the company owns half of the largest ethanol plants in the United States.
The overview below shows the company’s business segments.
On January 25, the company announced its earnings. In the two years prior to these earnings, the company had beaten revenue estimates 64% of the time. The company beat revenue estimates again in 4Q21, and it wasn’t even close. Total revenue came in at $23.1 billion. That’s 28.4% higher compared to the prior-year quarter and $2.88 billion higher than expected. That’s 14.2% higher than expected.
Prior to that, the company beat 3Q21 revenue expectations by $2.41 billion as it came in at $20.3 billion.
These were strong signs that the market and its participants (i.e., analysts) underestimated the significance of the bull market including commodity prices, domestic and export demand, and the ability of ADM to deliver.
This is what the CEO commented on January 25:
Our excellent performance in the fourth quarter and throughout 2021 gives us great momentum going into the new year. We’re confident in our strategic plan continuing to deliver, which is why we’re pleased to announce an 8% increase in our quarterly dividend. I’m proud of our team, grateful for their efforts, and optimistic for another very strong performance in 2022 as we progress towards our strategic plan’s next earnings milestone of $6.00-$7.00 per share.
Almost needless to say but the company benefited from growth across the board. The company benefits from $1.45 per gallon ethanol margins. That’s up from a mere $0.11 in 4Q20. The average daily volume (in the US) is now 1.1 million barrels, up from 957 thousand barrels. Spot gross crush margins for soybeans are currently $55-$65 in the US according to ADM estimates. That’s up another $5 compared to 3Q21. In Europe, it’s $60-$80. Up from $60-$70. In Brazil, export crush margins are now $30-$40, up from $10-$20.
Yet, volumes are not up because supply isn’t strong – one of the reasons why pricing is up. In 2021, total processed volumes (corn and oilseeds) were 54.3 million metric tons. Down from 54.5 million mt in 2020.
According to the company,
[…] looking ahead, we expect nutrition to continue to grow operating profits at a 15%-plus rate for calendar year 2022 with the first quarter similar to the first quarter of 2021, with continued revenue growth offset by some higher costs upfront in the year and the absence of the one-time benefits we saw in the first quarter of the prior year.
With that being said, the company is looking to do $86.2 billion in revenue this year. That’s up from $85.2 billion in 2021 and well-above pre-pandemic levels when the company did close to $64 billion in annual revenues. EBITDA this year is expected to be $4.9 billion. Personally, I believe that both numbers will come in higher than expected this year due to the bull market in agriculture that will not end unless energy prices take a big hit this year.
With regard to free cash flow, the company is set to do $2.4 billion in FCF this year. Next year it’s expected to rise to $2.9 billion based on higher net income and slightly lower CapEx.
Free cash flow is basically net income adjusted for non-cash items and capital expenditures. It’s money the company can spend on buybacks, dividends, debt reduction, and related. In the case of ADM, management is mainly looking to reduce debt and support the dividend. M&A in the past has caused CapEx to rise from the low $800 million range to $1.2 billion.
The good news is that the company is achieving both targets. Last month, it announced an 8% dividend hike, with an implied yield of 2.0% based on a $1.60 annual dividend yield (4x $0.40). This is the biggest hike since 2015. Note that the company has somewhat subdued dividend growth. Since 2009, dividends have grown by 8.4% per year. That’s high, but it’s mainly caused by a few high dividend hikes until 2015. After that, it dropped to the low-single-digit range.
The other target, reducing debt, is also being achieved. Net debt is expected to end this year at $7.1 billion. That implies a 1.5x net leverage ratio. It’s down from 2.6x prior to the pandemic, which was also sustainable.
Using the $42.4 billion market cap, $6.6 billion in 2023 expected net debt (to price in higher free cash flow), and $4.9 billion in EBITDA, we get an enterprise value of $49.0 billion, which is roughly 10x expected EBITDA.
This valuation is OK. It’s not at all overvalued given the historic valuation range. Also, I expect EBITDA to come in higher than expected, so if I’m right, analyst adjustments will support the stock this year as well.
Archer-Daniels-Midland is in a terrific position. The company benefits from high export demand, strong margins, rapidly rising energy prices (also impacting margins), and the fact that it has huge operations in the US, which only gives it an advantage due to difficulties in Ukraine and other countries.
The company crushed earnings last year and I believe that this will continue. This will lead to higher free cash flow used to further reduce debt and accelerate dividends.
The valuation is good, and I expect another 10-15% upside this year. Yet, I’m still using a neutral rating, which is technically a downgrade as I was bullish prior to this article.
Let me explain, despite everything, I don’t want readers to chase the stock at current prices. The dividend yield is not *that* high and the risk/reward has declined due to the Ukraine-related surge in the stock price – and the entire post-pandemic surge.
If you are a long-term dividend investor, do not sell a single share. I believe that ADM is a fantastic long-term investment that protects its shareholders against inflation. Yet, new investors should wait for weakness. I’m not a big fan of buying this stock with a yield close to 2%. Dividend growth and potential capital gains are simply not high enough to justify that investment. I believe that if we get good news from the Ukraine war, we might see weakness in ADM as well, which could give us new buying opportunities.
(Dis)agree? Let me know in the comments!