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This is it: the final installment of the 50-part 2016 Dividend Aristocrats in Focus series. You can see the entire list of Dividend Aristocrats here, including detailed analysis of all 50.
There’s no better way to acquaint yourself with what a high-quality dividend growth stock looks like.
Now, onto Dividend Aristocrat Archer Daniels Midland Company (ADM, Financial).
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, and the Archer Daniels Midland Company was born.
Today, it is an agricultural giant. Archer Daniels Midland operates in 160 countries and has more than 32,000 employees.
Over the course of its history as a company, Archer Daniels Midland has consistently rewarded shareholders. It has increased its dividend for years in a row.
Read on to see why Archer Daniels Midland can be a good stock to buy and hold over the long term.
Business overview
Archer Daniels Midland is an agricultural processing giant. It produces a wide range of products and services, designed to meet the growing demand for food as a result of rising populations.
The company operates in four segments:
- Agricultural Services (30% of operating profit).
- Corn Processing (33% of operating profit).
- Oilseeds Processing (22% of operating profit).
- WILD Flavors & Specialty Ingredients (11% of operating profit).
The remaining 4% of the company’s profits come from the “Other” category.
This is not an easy time for Archer Daniels Midland. The company is struggling with many challenges. A few of these include the strong U.S. dollar, which has made exports less competitive.
In addition, low prices reduced revenue, due to the decline in agricultural commodities. Finally, large global crop supplies over the past year have been an added headwind on pricing.
Because of these factors, Archer Daniels Midland’s net earnings fell 18% last year.
Unfortunately, conditions have not improved much to start 2016. Revenue and earnings per share declined 11% and 20%, respectively, through the first three quarters.
Despite these difficulties, the company is still successful. It has remained profitable throughout the recent downturn. It generates positive earnings thanks to its strong business model and a renewed focus on increasing efficiencies.
Source: 2016 CAGNY Presentation, page 12
Over the trailing four quarters, Archer Daniels Midland’s return on capital of 7.3% exceeded its weighted average cost of capital of 6.6%.
A continued emphasis on boosting efficiency to maintain profitability should help the company until the broader macro-environment improves.
Growth prospects
The decline in commodity prices has had a pronounced negative impact on Archer Daniels Midland. But there is still a path for future growth.
Source: Q3 Earnings Presentation, page 13
The first step of the growth plan is investment to grow the existing operations. Last year, the company invested $1.1 billion in projects to fuel future growth.
Aside from internal investment, management has a multi-faceted approach to restoring growth this year and beyond.
Source: 2016 CAGNY Presentation, page 22
Next, Archer Daniels Midland will generate EPS growth from margin expansion. The company is in the middle of a significant cost-cutting program. It expects to produce $275 million of cost cuts this year.
In addition, the company will continue to pursue bolt-on acquisitions to drive growth. Last year, the company made several acquisitions. Archer Daniels Midland purchased a 50% stake in Egypt’s Medsofts Group.
Separately, in the Corn Processing business, the company made two significant acquisitions. It purchased European sweetener company Eaststarch C.V., which gives it a solid foothold in the EU.
And, in the same division, the company acquired a wet mill in Morocco, further diversifying the geographic exposure of the sweetener business.
Competitive advantages and recession performance
In order to remain at the top of an industry for as long as Archer Daniels Midland has, sustainable competitive advantages are critical. In this case, the company’s biggest competitive advantage is economies of scale.
Archer Daniels Midland is an industry giant. In fact, it is the largest processor of corn in the world.
It has a $25 billion market capitalization. It has 428 crop procurement locations, 280 ingredient plants and 39 innovation centers.
Its global distribution system provides it with high margins and barriers to entry.
And, Archer Daniels Midland’s financial strength is a margin of safety. When times are tough (as they are now), the company can still remain profitable. It can also continue to raise capital at attractive rates, to continue investing in the business.
For example, it recently raised $1 billion in 10-year bonds with an attractive 2.5% interest rate. This is well below the company’s return on invested capital.
Over the past 12 months, Archer Daniels Midland generated a 5.8% ROIC.
The company’s EPS through the Great Recession of 2007 to 2009 are shown below to illustrate this point:
- 2007 EPS of $2.38
- 2008 EPS of $2.84
- 2009 EPS of $3.06
Grains still need to be processed and transported, even when the economy goes into recession. As a result, the company has a very recession resistant business model.
Valuation and expected total return
Archer Daniels Midland stock trades for a price-earnings ratio of 17. This is below the average market multiple. The S&P 500 index trades for a price-earnings ratio of 25.
However, Archer Daniels Midland stock has traded for an average price-earnings ratio of 15 since 2000. From that perspective, the stock is trading above its own historical average.
It appears the stock is fairly valued.
As a result, Archer Daniels Midland’s total returns moving forward will be comprised mostly of EPS growth.
A potential breakdown of the company’s potential future EPS growth could be as follows:
- 5-7% revenue growth.
- 1% profit margin expansion.
- 1% share repurchases.
- 2.8% dividend yield.
Future shareholder returns could reach around 10-12% per year going forward.
Final thoughts
Archer Daniels Midland has fallen on some hard times over the past year. Net profits continue to fall. However, the company has a long track record of navigating the ups and downs of its cyclical industry.
It has made 340 consecutive quarterly dividend payments, a streak going back 85 years.
Archer Daniels Midland has a proven business model that has stood the test of time. Its short-term challenges will likely ease with time.
Investors may need to exercise patience, but the stock continues to be a valuable hold for dividend growth investors.
Disclosure: I am long ADM.
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Published Nov. 23 by Bob Ciura
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