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Introduction
Archer-Daniels-Midland Company (NYSE:ADM) recently announced earnings, and the market used the stock as a pinata. Despite beating expectations, the stock was down -4.28% for the week ending on October 27, 2023. This extended a downward trend for the 12 months that has seen the company’s value decline -26%. This would be otherwise surprising but is part of an overall pattern that has seen dividend darlings hammered over the last two years. No doubt, rising interest rates have yield-hunters looking for safer havens.
Archer-Daniels-Midland Company is a human and animal nutrition company. The Company is an agricultural supply chain manager and processor. It operates through three business segments: Ag Services and Oilseeds, Carbohydrate Solutions, and Nutrition. The Ag Services and Oilseeds segment includes global activities related to the origination, merchandising, transportation, and storage of agricultural raw materials, and the crushing and further processing of oilseeds such as soybeans and soft seeds into vegetable oils and protein meals. The Carbohydrate Solutions segment is engaged in corn and wheat wet and dry milling and other activities. The Nutrition segment is engaged in the manufacturing, sale, and distribution of a range of ingredients and solutions, including plant-based proteins, natural flavors, flavor systems, natural colors, emulsifiers, soluble fiber, polyols, hydrocolloids, probiotics, prebiotics, enzymes, botanical extracts, and other specialty food and feed ingredients.
This is how others rate Archer-Daniels:
- Morningstar – Hold
- Zacks – Hold
- The Street – Buy
- Market Edge – Long
- General Consensus – Buy
Methodology Disclosure
I am a quantitative analyst. I put little stock in making future predictions about what a company will or will not do. My preference is to analyze the revenue of a company over the last five years and make determinations for earnings and free cash flow from there. I contend that most financial results for a company are the function of sales. The direction of sales dictates everything else for a corporation and one will that is the basis of all analysis I do.
Balance Sheet
Any passing company must have a clean balance sheet. These are my criteria, and how ADM compares.
- Debt-to-Equity is 0.39
- The Current Ratio is 1.60
- Must be greater than 1.5.
- Altman-Z is 3.65
- Must be greater than 3.0.
- Free Cash Flow is $3.62B
All the metrics have a passing grade.
Revenue Analysis
ADM has seen its revenue grow at an annual rate of 9.00% since 2018, and it has a regressed growth rate of 12.35%. Its historical price-to-sales ratio has been as low as 0.37 and as high as 0.54. Its five-year average is 0.45.
Data from Morningstar
ADM has a historical beta of 0.69 which gives me a required rate of return of 8.45%. Based on historical metrics, these are the present values for ADM determined by revenue growth:
- Bearish Case: $83.95/share
- Bullish Case: $117.01/share
- Fair Value: $99.51/share
Earnings Analysis
Given that ADM is in a low-margin industry, its Cost of Goods Sold average rate is around 92%. Couple that with an SG&A rate of 3%. I also see a future tax margin of 18% based on general trends and potential legislation. As I run my projections, earnings growth should be 5.08% per year for the next five years.
Data from Morningstar
Historically, ADM’s Price/Earnings ratio ran from a low of 8.86 to a high of 22.01. The five-year average for the P/E ratio is 13.97. Here is how I see the value of ADM as determined by earnings growth:
- Bearish Case: $89.08
- Bullish Case: $203.51
- Fair Value: $133.54
Free Cash Flow Analysis
ADM had negative free cash flow for 2018-2020. It returned to a positive position in 2021 and has maintained that through the third quarter of this year. If they can maintain their recent consistency, and revenue continues to grow, they should remain positive for the next few years. This remains a key concern as I look at the analysis. If it cannot maintain its positive position, I will be quick to change my mind.
Data from Morningstar
I am making other assumptions too. I see its cost of debt at 5.9% and its WACC at 7.2%. When I conduct my sensitivity tests, I usually assume an assumed long-term growth rate of 1%-3%. At this time, I would like to see a consistent trend in their statements of cash flow before I peg an actual value on this stock. I do see it as undervalued based on the numbers, but I have a low confidence rate in those valuations.
Growth Rating
We now have two net present values for ADM and are now able to give it a growth rating:
- Balance Sheet: Pass
- Revenue Analysis: Pass
- Earnings Analysis: Pass
- Free Cash Flow Analysis: Neutral
- Pass Growth Rating: 4-Star (BUY)
For any of this to hold, one would have to assume the recent downturn in sales is an anomaly. Many of the valuations are also based on a company that has been beaten down recently given that its price has suffered a -25% loss. While I am giving it a growth rating, the potential gains one might see for this investment are due to it being so cheap right now.
Dividend Analysis and Rating
If I were to consider a stock as an income investment, there exist some basic requirements for my consideration.
- The current yield is 2.57% and the historical yield is 2.56%.
- Annual dividend increases every year since 1998.
- Must be for at least 10 consecutive years.
Based on the revenue trends from the last five years, this is how I see the future dividends growing for ADM. I am assuming a regressed dividend growth rate of 5.08%.
Data from Morningstar
Based on future dividend growth, I calculate ADM’s present value at $68.25/share. This is less than its current price of $70.04. This is how I score ADM as a dividend stock:
- Balance Sheet: Pass
- Current Yield: Pass
- Free Cash Flow Analysis: Neutral
- Discounted Dividend Analysis: Fail
- Income Rating: 3-Star (Hold)
My Take
It is worth noting that if ADM continues to see declining sales and cannot maintain positive free cash flow, the dividend is at risk for reduction or elimination. Archer-Daniels-Midland’s investment success hinges on its ability to remain free cash flow positive. If I had some certainty that could happen, I would be more vigorous in my recommendations. As one can see from the chart provided, the free cash flow has been declining, so my concerns about it going negative are real. There does appear to be undervalued growth for sales and earnings, so I can give a tepid BUY recommendation.
Good luck out there.
