Archer-Daniels-Midland: Transforming Its Business Away From Commodities (NYSE:ADM)

Investment Thesis

Over the last 2 years, I believe Archer-Daniels-Midland (NYSE:ADM) has risen above the pack (even through the Ukraine war and volatile crop markets) for its resilience and adaptability in such challenging global conditions.

In my opinion, the company’s strategic navigation, especially with its solid (in spite of the environment) 2023 earnings, highlights its stellar market positioning and operational effectiveness. ADM’s investment in BioSolutions and renewable diesel, exemplified by the Green Bison Production Facility, aligns with current global sustainability trends. By diversifying its revenue streams it has allowed the firm to be less dependent on unpredictable crop prices.

With strong tailwinds and efforts to diversify the business, I think ADM’s metrics present an undervalued investment opportunity. The company’s lower than sector median (FWD) Non-GAAP P/E and (FWD) EV/EBITDA, along with its strong commitment to shareholder returns, presents an interesting investment profile. Return potentials could be north of 60% before the shares are close to their fair relative value.

In my opinion, ADM has the promise to be a solid compounder for an investor’s portfolio. I think the stock is a buy.

Background

Archer-Daniels-Midland is one of the 4 largest global grain trading and agricultural businesses. Since the war in Ukraine (which disrupted some of the firm’s operations) the company has executed extremely well, demonstrating remarkable resilience and adaptability.

How They Have Responded

The onset of the Ukraine war in early 2022 significantly disrupted global agricultural supply chains. Ukraine and Russia, major global suppliers of wheat, corn, and sunflower oil, saw their exports severely impacted due to the conflict. Broken supply chains from Eastern Europe created a surge in global demand for alternative sources, with companies like ADM benefiting from increased demand for crops they could provide. The war also heightened global food inflation concerns, which further played into ADM’s strengths in the agri-commodity market as the prices for the grain products they ship jumped. In essence, ADM benefited from stronger volume and a better pricing mix. I can’t think of a better combination for any business.

ADM responded swiftly to the changing scenario by shutting down its facilities in Ukraine, including an oilseed crush plant and a grain export terminal. Despite these operational challenges, ADM leveraged its global presence to manage the impacts effectively. The company capitalized on strong crop processing margins and the tightened supply of agricultural products, resulting in substantial earnings. This robust performance was reflected in ADM’s Q3 2023 financial reports, showcasing operating earnings of $1.421 billion. While these earnings were down from $1.559 billion in the third quarter last year, management raised guidance and expects to earn more than $7/share in EPS this year (2023).

Post-Ukraine War Developments

In the aftermath of the initial stages of the Ukraine conflict, ADM’s management has leaned on their Ag Services & Oilseeds segment, successfully utilizing Brazilian export capabilities, while the Carbohydrate Solutions segment gained from favorable margins in ethanol, starches, and sweeteners.

Global crop supplies have remained tight due to the war, with analysts predicting that the demand would outpace supplies until at least 2024. This tight supply-demand balance has led to sustained higher crop prices and encouraged increased planting in regions like South America. ADM’s efficient ability to ride these global trends further solidified its market position. With the strong market conditions, analysts are expecting ADM’s profitability to continue to be strong, holding at around an estimated 2024 full-year EPS of $6.58/share.

Strategic Initiatives Changing the Business

Using their stronger profits, ADM has pushed to make significant strategic changes by investing in renewable diesel and BioSolutions, aligning with global trends towards sustainability and renewable energy along with vying to remove part of its dependence on volatile global crop prices.

One development in this strategy is the company breaking ground on the Green Bison Production Facility in North Dakota, which is the state’s first dedicated soybean processing plant. ADM management believes this facility is expected to be operational by the end of this year and projects to produce around 600 million pounds of refined vegetable oil annually. This output will primarily support approximately 75 million gallons of annual renewable diesel production​​.

In essence, ADM is strategically adapting its business model to ensure financial stability and align with global environmental trends. They are using the solid hand they have with strong crop prices to build a more robust business.

A big key to this strategy is the shift in focus within its Carbohydrate Solutions segment, aimed at reducing dependence on volatile commodities like ethanol. This shift helps stabilize revenue streams against market fluctuations influenced by external factors such as global trade dynamics. With this, ADM is investing in renewable diesel and BioSolutions, responding to the growing global demand for sustainable and eco-friendly products.

These investments in renewable energy sources and sustainable agriculture solutions, such as biopesticides and biostimulants, position ADM at the forefront of the sustainable agriculture sector.

Valuation

In my opinion, ADM displays a strong valuation compared to the sector median in several key metrics. Their (FWD) Non-GAAP P/E 10.14, significantly lower than the sector median of 17.67, indicates a solid place for shares to grow. Similarly, in terms of EV/EBITDA (FWD), ADM’s stock stands at 7.66, compared to the sector median of 11.22, a -31.68% difference.

What I think the Fair Value of ADM Is (Based on Sector Medians)

If investors begin to price in the firm’s adjustments through their new strategic initiatives, ADM stock could see upwards of 60% upside (this assumes that the forward PE and EV/EBITDA ratios converge just on the sector median). Based on the $73.75 close on Friday, December 8th, this would value ADM at around $118/share.

What I think ADM is Worth (Based on Trough PE Multiples)

While a forward PE of ~17 may feel like an extreme jump from current PE ratios, I think it’s key to clarify where I think we are in the agriculture commodities cycle. Key supplies of grains are expected to be tight into next year and ADM is diversifying its business to be more resistant to commodity cycles. In essence, I expect their EPS (after the drop to an estimates $6.53 next year) to largely grow going forward. Given this, we should be near the trough of the cycle for crop prices for ADM (and trough of EPS).

Given this, a PE of ~17 doesn’t seem too extreme. For example, below is a chart showing the forward PE multiple of ADM over the last 23 years. ADMs forward PE was well north of 20 in previous trough cycles. Given a trough PE of 20 and a forward (trough) EPS estimate of $6.53, this implies a share value of ~$130/share.

Using a blending valuation estimate, I believe the fair value of ADM stock to be approx. $125/share over the next 12-18 months.

ADM is excelling in a dynamic market, I think they have room to run & converge on just the sector median.

Shareholder-Friendly Culture

As an added bonus, with a solid forward valuation comes a compelling history of rewarding shareholders while they wait for shares to appreciate. ADM has shown a strong commitment to shareholder returns, notably through its consistent dividend increases. ADM has achieved the status of a dividend king, marking over 50 consecutive years of dividend hikes. Investors can come to expect solid dividend payments from this agricultural giant even as it undergoes a major transformation. This is shrewd management being able to deliver on long-term value while being able to reward shareholders today.

Dividends aren’t the only way ADM has rewarded their shareholder base. ADM has also been actively engaging in stock buybacks. In 2023 alone, the company executed significant buybacks, including $117 million in the third quarter, $650 million in the quarter ending in June, and $351 million in Q1. This follows a $250 million buyback at the end of 2022, meaning trailing 4 quarter buybacks have been $1.368 billion. Together, with dividends, the firm is presenting investors with a combined shareholder yield of almost 6% (5.917%).

Great valuation and excellent shareholder yield make this incredibly compelling for me.

Risks

While management is trying to transition away from it, ADM still faces risks associated with volatile crop prices, which can significantly impact its financial performance. ADM’s revenue and profit margins are currently highly correlated with agricultural commodity market prices. As one example, swings in its free cash flow could be extreme from quarter to quarter, due to changes in the Grain and Oilseed Milling Producer Price Index (PPI) which tracks the costs of the underlying goods that ADM marks up for a profit in their trading business​​​​.

Further, on the point of volatility, ADM’s results are also not just influenced by market prices but also by weather and geopolitical events. Despite ADM’s initiatives to reduce reliance on volatile commodity markets by diversifying into areas like carbon reduction and sustainable alternative food sources, the company’s exposure to these market dynamics remains a significant risk factor.

However, I think this is also a place where (if management executes well) ADM has demonstrated a history of being able to excel with tough weather conditions, like this past summer with an El Nino weather pattern.

Takeaway

In my opinion, ADM has emerged as a compelling investment opportunity, combining opportunity execution by management in challenging market conditions with strategic foresight and shareholder-friendly policies. Amidst the volatile backdrop of the continued Ukraine war and global inflation, ADM has not only managed to sustain its operations but also capitalized on the resulting market shifts.

With this effective management, the company’s strategic investments in renewable diesel and BioSolutions further fortify its long-term growth prospects. The firm’s shareholder-friendly action in the process of transformation and highly favorable relative valuation (to the sector), in my opinion, more than justify the risks related to investing in a firm that is exposed to volatile crop prices. I think the stock is a buy.