Published by Bob Ciura on November 7th, 2017
The Dividend Aristocrats are a group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Each year, we review all 51 Dividend Aristocrats. Next up in the 2017 edition is Archer Daniels Midland (ADM).
Archer Daniels Midland has had a tough year. Shares are down 15% year-to-date. Looking further back, the stock has declined approximately 25% from its five-year peak.
The fundamentals of the company’s core industries have deteriorated in recent years. The decline in agriculture commodity prices has caused deflation, which has eroded profit margins.
However, the company has remained steadily profitable. This has allowed it to continue raising its dividend, including a healthy 6.7% increase in 2017.
And, industry conditions have improved this year, which could pave the way for a recovery in 2018 and beyond.
Business Overview
Archer Daniels Midland was founded in 1902, when George A. Archer and John W. Daniels began a linseed crushing business.
In 1923, Archer-Daniels Linseed Company acquired Midland Linseed Products Company, which created Archer Daniels Midland.
Today, it is an agricultural giant. Archer-Daniels-Midland operates in 160 countries and generates annual revenue above $62 billion.
The company produces a wide range of products and services, designed to meet the growing demand for food due to rising populations.
Source: September Investor Presentation, page 4
It operates four business segments:
- Agricultural Services (16% of operating profit)
- Corn Processing (47% of operating profit)
- Oilseeds Processing (22% of operating profit)
- WILD Flavors & Specialty Ingredients (11% of operating profit)
The remaining 4% of operating profit is derived from a non-core ‘other’ segment.
This is a difficult time for Archer Daniels Midland. It is fighting through many challenges, such as the strong U.S. dollar, and the decline in agricultural commodities such as corn.
Margins have declined across Archer Daniels Midland’s business model. Finally, large global crop supplies over the past year have been an added headwind on pricing.
As a result, earnings fell 18% in 2015. Conditions did not improve much in 2016. Archer Daniels Midland’s total sales fell 7.9% in 2016, along with a 27% decline in diluted earnings-per-share.
Despite a weak operating environment, Archer Daniels Midland has remained profitable thanks to cost controls. And, industry conditions have improved, which could set the stage for a return to growth next year.
Growth Prospects
Conditions have improved for Archer Daniels Midland, to start 2017. Revenue declined just 2.7% over the first three quarters of 2017. Earnings-per-share were also down by just 2% in that time.
Source: Q3 Earnings Presentation, page 8
Margins remain under pressure, as agricultural services operating profit is down 13% in the first nine months. However, growth across other segments has helped offset this. For example, operating profit in the corn processing increased 27% in the same period.
Cost cuts have also helped. Last year, Archer Daniels Midland eliminated over $300 million in run-rate costs.
Going forward, the company can still invest in growth initiatives to turn itself around. One of the ways is through portfolio optimization through acquisitions and divestitures.
Source: September Investor Presentation, page 11
The company expects annual revenue growth of $500 million due to acquisitions and other investments conducted last year.
Archer Daniels Midland also frequently divests low-growth businesses, to further improve its portfolio.
Earnings will also be boosted by the company’s share buybacks. This is a benefit of remaining consistently profitable during industry downturns—the company can use some of its excess cash flow to repurchase shares at lower prices.
Archer Daniels Midland reduced its diluted share count by 4.8% in 2016. It returned $1.7 billion to shareholders in dividends and share buybacks during the year.
Competitive Advantages & Recession Performance
Archer Daniels Midland has built significant competitive advantages over the year. It is the largest processor of corn in the world. This gives way to economies of scale and efficiencies in production and distribution.
The company has a $21.9 billion market capitalization. It is an industry giant, with 500 crop procurement locations, 250 ingredient manufacturing facilities, and 38 innovation centers.
At its innovation centers, the company conducts research and development on how to more effectively respond to changes in customer demand, and improving processing efficiency.
Archer Daniels Midland has an unparalleled global transportation network.
Source: September Investor Presentation, page 6
The company’s global distribution system provides the company with high margins and barriers to entry. In turn, this allows Archer Daniels Midland to remain highly profitable, even during industry downturns.
Profits held up, even during the Great Recession. Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $2.38
- 2008 earnings-per-share of $2.84 (19% increase)
- 2009 earnings-per-share of $3.06 (7.7% increase)
- 2010 earnings-per-share of $3.06
Grains still need to be processed and transported, even during recessions. There will always be a certain level of demand for Archer Daniels Midland’s products.
Valuation & Expected Returns
Archer Daniels Midland stock trades for a price-to-earnings ratio of 18.4. This is well below the S&P 500 Index, which has an average price-to-earnings ratio of 25.8.
According to ValueLine estimates, in the past 10 years, the stock held an average price-to-earnings ratio of just 13.6.
Source: Value Line
At first glance, Archer Daniels Midland appears significantly overvalued. But the image above is misleading. The price-to-earnings ratio is typically a good way to gauge valuation levels for established businesses… But not always.
Archer Daniels Midland’s profits are volatile and fluctuate with the price of grains and commodities like oil. When oil prices are low, ethanol demand declines, which hurts Archer Daniel Midland’s profits. The company’s book value is far more stable and gives a better idea of the company’s ‘real’ value relative to its history.
Archer Daniel Midland’s 10 year average price-to-book ratio is 1.36. The company is currently trading for a price-to book ratio of 1.27 at current prices. The company appears to be a bit undervalued at current prices.
Future returns will be comprised primarily of earnings growth and dividends rather than valuation multiple changes. While Archer Daniels Midland is undervalued, it isn’t significantly undervalued. ValueLine analysts expect earnings to grow 14% next year, and roughly 6%-7% annually through 2020.
Based on this, future returns could be as follows:
- 3%-4% revenue growth
- 1% margin expansion
- 1%-2% share repurchases
- 3% dividend yield
In this scenario, earnings would grow 5%-7% per year. Adding the 3% dividend yield, total returns would reach 8%-10% per year.
Final Thoughts
Archer Daniels Midland has encountered a difficult operating environment. It is being negatively impacted by declining prices of agricultural commodities and oil, which has weighed on its earnings in recent years.
With that said, the company has a long history of navigating through challenging periods. It has continued to generate profits and reward shareholders with rising dividends along the way.
The stock could be undervalued, and pays a solid 3% dividend plus annual dividend increases. As a result, Archer Daniels Midland appears to be an attractively valued dividend growth stock.
