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Archer Daniels Midland – an important link in the food industry
The last Archer Daniels Midland quarterly figures for September 2024
Stocks from the food industry are considered defensive and often shine with stable cash flows that can be used for steadily increasing dividend payments. That is why many companies in this sector have earned the status of a dividend king This also applies to the American company Archer Daniels Midland (ISIN: US0394831020), which has increased its dividend every year for over 50 years.
Source: Archer Daniels Midland Stock
But the nimbus is crumbling, because the company currently has various challenges to overcome, which is why the share price has corrected significantly in the last year
At the beginning of 2024, for example, there were reports that management had manipulated its income statement in one division. This triggered a slide in the share price.
However, the company can still count on recurring cash flows, as the Americans are a very important player in the global food industry.
Does the risk that there may be structural governance problems at Archer Daniels Midland (ADM) now prevail, or does a historically favourable entry opportunity present itself for investors in the case of a dividend king?
We get to the bottom of it all as part of an Archer Daniels Midland stock analysis
Archer Daniels Midland was founded in 1902. The company specialises in the storage, drying, processing and transport of staple foods such as soybeans, corn, canola and various types of grain.
Source: ADM – company presentation
The company's importance can be seen from the value chain. ADM dries and stores raw materials and processes them into various products. These can be vegetable oils, flours, starches and sweeteners or special flavourings, pet food and speciality foods.
To put it simply, the Americans are the link between agriculture and the food processing industry, making them an important player for both sides. The agricultural companies depend on ADM's raw material purchasing, and the large food manufacturers need the intermediate products produced by Archer Daniels Midland.
Although the product range is large and diverse, ADM faces the same challenges every year Revenue growth is heavily dependent on the volume of the harvests of the raw materials and their prices on the world market. In addition, ADM must manage its costs very well to achieve sustainable profits.
Source: Archer Daniels Midland Margins
Currently, the gross margin is just 6.7 per cent and the EBIT margin is only 2.6 per cent In other words, over 90 per cent of sales are already consumed by product costs, i.e. the costs of purchasing raw materials, transporting them, producing and distributing them.
This chart clearly shows how low-margin Archer Daniels Midland's business is and how little leeway it allows for mistakes. Sales of soybeans, soybean-based products and corn are particularly important for ADM Together, these three goods account for 43 per cent of total sales.
Although Archer Daniels Midland is a very important part of the global food industry, the business has very low margins. Furthermore, there is no sustainable competitive advantage, as ADM's customers can also purchase their intermediate products from a competitor.
In January 2024, the US Securities and Exchange Commission (SEC) launched an investigation into events in the financial accounting of Archer Daniels Midland.
ADM's management responded immediately, launching its own internal investigation and placing its CFO, Vikram Luthar, on administrative leave. He resigned shortly thereafter. The matter concerns improper shifts of manufacturing costs in the income statement to make the operating profits of the Nutrition division appear better than they ultimately were. As a result of the investigation, ADM had to correct its Nutrition division's EBIT results for the last five years downwards by a total of almost $230 million. The investigation is still ongoing and so far ADM CEO Juan Luciano has not commented in detail on the allegations.
This investigation and how ADM management responds to the allegations could be a red flag for investors. To put this into perspective, it should be added that, as things currently stand, there are no fundamental allegations of fraud regarding the business as a whole, as was the case with the German company Wirecard AG a few years ago. Nevertheless, the allegations and the SEC investigation are an important point that investors should monitor.
In its 2023 annual report, Archer Daniels Midland reports total revenue of around $94 billion.
Source: Annual Report ADM 2023
This represented a decline of 7.5 per cent. We can see most of the decline in the first division.
The Ag Services & Oilseeds division accounts for 78 per cent of total sales. After almost $80 billion in 2022, it is only $73.4 billion in 2023. This corresponds to an 8 per cent decline
In this segment, raw materials are bought and sold directly under Ag Services, without ADM processing them further. At $47 billion, this segment accounts for 50 percent of Archer Daniels Midland's total sales. Although ADM was able to report a higher volume for the harvest, the prices achieved were lower than in 2022. This once again highlights the company's dependence on world market prices In the Crushing and Refined Products divisions, raw materials are processed and can then be used to produce biodiesel or salad oils. The Crushing division recorded a 6.7 per cent increase in sales last year.
Carbohydrate Solutions includes all offerings for sweeteners, starches, cereal flours, glucoses and various waste products from the production of these products, such as ethyl alcohol, which is used in the production of disinfectants. Last year, the division's share of sales was around 14 per cent. At $12.9 billion, sales were about 8 per cent lower than in the previous year Here, too, ADM cited higher sales volumes but also lower sales prices as the reason for the decline in sales.
The Nutrition business, which is so important to ADM management because it is actually the fastest growing area, also recorded a decline in sales. The figure shows a minus of 6 per cent. In this segment, volumes declined but higher sales prices were achieved
It offers various food products for humans and animals. These include plant-based proteins, flavourings and nutritional supplements.
The figures from this division are the focus of particular attention for two reasons. Firstly, they are the subject of the SEC investigation and, secondly, ADM management wants to achieve higher growth and better margins with this division. Neither is currently in sight.
This segment combines all of Archer Daniels Midland's trading activities not yet mentioned. ADM uses derivatives trading on the futures markets to hedge its raw material purchases through various subsidiaries. This segment recorded a 7 per cent increase in sales and generated $424 million in revenue.
Archer Daniels Midland's economic success depends to a considerable extent on external factors. Management cites many different reasons for the decline in profits in 2023.
In South America, poor harvests contributed to the failure of the Ag Services & Oilseeds division. In addition, the war in Ukraine has caused high volatility in the commodity markets Shipping container rates also had an impact on the income statement, as did weather-related influences on supply chains.
These unforeseeable influences make revenue and profit forecasts only partially possible. In addition, there are further uncertainties due to the SEC investigation.
Investors punished the latest reported quarterly figures from Archer Daniels Midland with a 6 per cent drop in the share price on the day of publication.
Source: Price reaction of Archer Daniels Midland shares, quarterly figures
There was a reason for this correction in the share price. Revenue fell by 8 per cent to $19.94 billion.
Source: Archer Daniels Midland Share Quarterly figures September 2024
Operating profit was significantly lower. EBIT fell by 47 per cent to $535 million. Net profit of just $18 million was down 98 per cent on the same quarter last year
The reason for the significant drop in profits was write-offs on assets in the balance sheet of $43 million and losses from an investment transaction of $460 million.
The reported quarterly figures show a dramatic decline in profitability, which investors must subsequently observe. Management should be under more scrutiny than ever.
With the weak quarterly figures for the past quarter just considered, analysts' forecasts are not surprising. Revenues of $86 billion are expected for the current fiscal year. This would be an 8 per cent decline compared to fiscal year 2023.
Source: Archer Daniels Midland Forecast 2024
According to estimates, the profit margin is also expected to continue to fall and will be only 2.35 per cent.
Source: Archer Daniels Midland forecast 2024-2026
According to analysts' forecasts, revenue growth is expected to pick up again by 2026. However, the average expected revenue in 2026 is $91 billion, which would still be below the 2023 figure of $94 billion.
Source: Archer Daniels Midland forecast 2024-2026
The average estimates of net profit for the next few years also look modest Net income in 2026 is expected to be $2.5 billion, about 20 per cent below net income in 2023. However, analysts' estimates call for a modest increase in net margin to 2.75 per cent. For the current fiscal year, this is expected to be only 2.35 per cent
The forecasts for profitability look just as modest as the estimates for sales. It can be seen from the analysts' estimates that investors might not be so happy with the ADM share in the next two years either, as the increases in sales and profits could be very low.
The Archer Daniels Midland stock is currently the top scorer with 12 points according to the dividend strategy. The stable business model in the defensive food sector forms the basis for a sustainable dividend policy for the Americans. To be placed among the top scorer dividend stocks, the ADM share had to score at least 12 points.
Source: Archer Daniels Midland Share Dividend
For 51 years now, the company has increased its profit distribution every year. Since the share price has fallen in recent years, the current dividend yield is almost 4 per cent.
According to the dividend strategy, this scores 2 points. The average dividend yield over the last 10 years of 2.71 per cent also scores 2 points.
Source: Archer Daniels Midland Share Dividend
The stock performs better in terms of the payout ratio. This has been only 25 per cent over the last three years. The stock receives three points for this and a further three points for the continuity of the dividend payments over the last ten years. Finally, the Americans receive another two points for the average annual increases of over seven per cent This is solid value for a defensive food company.
Let's take another look at the low payout ratio of 25 per cent. This raises the question of how ADM management uses the remaining net profit.
For a better view, let's look at the free cash flow (FCF).
Source: Archer Daniels Midland Share Capital Allocation
For about two years, the free cash flow has been clearly positive again, after being negative in 2020 and 2021. Currently, the FCF is around $3.5 billion. In addition to the steadily increasing dividend payment, the management of Archer Daniels Midland is currently very eager to buy back its own shares. In the last three years, the number of outstanding shares has been reduced by around 15 per cent.
ADM's management currently seems to view the stock as very favourably valued. At least that is one way to explain the large share buyback programme. For investors, this means a steadily increasing stake in the company.
For the moment, the dividend of the ADM share seems secure. The low payout ratio and the stable business model despite all the challenges speak for this. In addition, investors can currently enjoy share buybacks.
We now look at the valuation of the Archer Daniels Midland stock.
Source: Archer Daniels Midland Share Valuation ratios
The price-earnings ratio (P/E ratio) is currently 14, which does not make the share look cheap if we include the sales trend in the valuation. The enterprise value/free cash flow (EV/FCF) ratio of 9 looks better. However, we have already seen that the FCF is quite volatile. ADM has to show that it can sustainably increase its free cash flow. The price-to-book ratio (P/B), which is around 1, does not make the stock appear expensive either
However, the fluctuating sales and earnings performance means that it could not be a bargain stock.
To better understand the valuation of Archer Daniels Midland, we will look at a competitor. The Bermuda-based company Bunge Ltd. has a corporate profile almost identical to ADM's.
Source: Archer Daniels Midland & Bunge Head-to-Head
Bunge's P/E ratio is only 10 and it has also seen a decline in sales of around 11 per cent. Bunge's EV/Sales of 0.3 is also below ADM's, whose sales multiple in relation to enterprise value is 0.37. The P/B ratio is the same for both companies at 1.1.
We have already found out that ADM can achieve its profitability particularly through effective cost management and efficient capital allocation. But how does Bunge compare in this regard? Sales per employee at Archer Daniels Midland are currently $2.25 million. At Bunge, on the other hand, an employee generates sales of $2.59 million. Bunge therefore seems to deploy its staff better.
Another KPI is the return on equity. This is 14.24 per cent at ADM. Bunge, on the other hand, has a figure of 19 per cent and therefore seems to be able to generate a better return on its capital
Bunge Ltd. appears more interesting than Archer Daniels Midland in the head-to-head comparison, as the company can generate a better return on its capital and deploy its staff more effectively. In addition, the share appears to be valued a little more favourably.
Based on the analysis carried out, Archer Daniels Midland's stock could not be bought at present. Although the largely stable business model speaks in favour of the Americans, many success factors depend on external events.
The list of questions is long:
At the moment, no precise answer can be found to any of these questions. Therefore, a certain amount of caution may be appropriate. This assessment is also confirmed by the analysts' recommendations.
Source: Archer Daniels Midland Price targets from analyst
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The author and/or persons or companies associated with the StocksGuide own or may own shares in Archer Daniels Midland. This article represents an expression of opinion and not investment advice. Please note the legal information.