Archer-Daniels-Midland: An agricultural giant with limited near-term upside potential (NYSE: ADM)

Investment thesis

I discovered Archer-Daniels-Midland (NYSE:ADM) few months ago. It appeared on my screen thanks to the improvement in its profitability and its health report. I started my coverage on the company in January.

Despite the provoking news significant short-term volatility, my thoughts remain largely unchanged. The company has had a great two years thanks to supply chain constraints and rising agricultural commodity prices. Today, prices are normalizing and long-term trends suggest a stable rather than improving outlook.

I still think it's a great deal. However, it is clear to me that the situation will face considerable difficulties, and the market has correctly assessed its current position. Therefore, I am maintaining my “Hold” rating for the title.

This analysis will briefly review the company description, discuss recent developments, and highlight long-term trends and near-term prospects.

activity Descrition

Although This is a follow-up article, I still want to briefly return to the description of the company. Please refer to my initial analysis of the company if you need a more detailed understanding.

Archer-Daniels-Midland is one of the world's largest agricultural supply chain managers. It owns and has access to numerous facilities, farms and supply chains. They enable the company to offer a wide range of food and beverage products.

The table below from the December 2023 investor presentation effectively explains the size and establishment of the company.

The Company has three operating segments. The most important by far is AG Services and Oilseeds. This is where the company sees the advantages of its size. In this segment, ADM sources agricultural raw materials from around the world, sells them, transports them and stores them. Its facilities also allow the company to supply by-products from the crushing and processing of oilseeds. Oilseeds, crude vegetable oils, salad oils and other food products are some of the products in this segment.

The second largest segment is carbohydrate solutions. This segment focuses on the processing of corn and wheat through wet and dry milling methods. Some end products are sweeteners, corn and wheat starches, syrup, glucose and wheat flour.

The smallest segment by revenue is nutrition, where ADM manufactures a wide range of ingredients, flavors, colors, proteins and other products, including treats and pet foods of company.

Below is a summary of ADM's value chain and revenue by segment over the past few quarters.

Recent Developments and Stock Performance

Interestingly, the stock plunged right after I published my initial coverage on ADM on January 18, 2024. The stock fell almost 25% in one day. Since then, the stock has surged 20%, while the S&P 500 index has risen nearly 9%.

The stock didn't fall for no reason. On January 21, ADM CFO was placed on administrative leave due to an investigation into certain accounting practices. Management announced a delay in releasing fourth-quarter results and filing the $10,000, provoking a massive and seemingly unwarranted backlash.

When the company finally released the fourth quarter earnings report, the market realized that the situation was not as bad as it feared. Revenue and EPS slightly missed estimates, but the 2024 guidance was in line with analyst estimates.

Just before the company reported its first quarter results, the chief financial officer agreed to resign effective September 30 due to ongoing investigations by the U.S. Department of Justice. The company slightly beat EPS estimates and missed revenue estimates by 2% in the first quarter.

The biggest news is that management pointed to difficult market conditions and supply chain complexity as reasons for the decline in revenue and profits compared to last year. We will discuss this in more detail in the next section.

Long-term factors and short-term outlook

Although the three segments have slightly different drivers, given the company's sustained positioning in the market, the long-term outlook boils down to three variables.

While WMD feeds the world, the first variable is population growth. This phenomenon is generally stable from one year to the next and its effects can only be observed after several decades. The U.S. population has grown nearly 35% since 1990, while it has increased just 0.5% since last year. The second variable is the amount of food consumed per person. Although this figure is generally stable from year to year, new weight loss drugs like Ozempic can reduce food consumption.

The third variable, which probably affects the carbohydrate solutions segment the most, is per capita use of sweeteners. Per capita shipments of sweeteners for domestic foods and beverages increased significantly between 1966 and 2000, but have been on a downward trend since then, according to the United States Department of Agriculture. This decline appears to offset the increase in population.

Archer-Daniels-Midland has a well-established presence in the agricultural supply chain and the variables we have discussed have helped it become a very stable company. Below is the adjusted return on assets [ROA] company graphic. Aside from the temporary increase in ROA in 2022 and 2023 due to supply chain constraints caused by the Russian-Ukrainian war, ADM maintained an ROA of approximately 9%.

Prices of agricultural products, particularly wheat, are normalizing since the surge in early 2022. Prices have been increasing recently, but this appears to be due to volatile weather conditions, and is not a long-term trend.

As pricing normalizes, I expect the company's operations to also normalize, leading to a gradual return of ROA to levels of 9-10%.

Assessment

Operating a business of this scale requires a significant asset base. ADM has numerous processing and storage facilities, rail cars, trailers and ports. That's why I think the sale price [P/B] is an appropriate valuation measure for this company.

The company's adjusted booking price has been around 1x since the Great Recession. There have been ups and downs, and with the war between Russia and Ukraine, the market recognized the potential for higher margins from rising prices. Adjusted P/B increased to 1.8x in 2022. The company was already experiencing issues as agricultural commodity prices normalized, so a decline in ROA and P/B was expected. However, the accounting investigation acted as a catalyst for the market and valuations fell rapidly.

Currently, the stock trades at an adjusted P/B ratio of 1.2x. As I expect ROA to decline due to normalization, I believe the current valuation is slightly at the upper end of the fair value range. The stock is trading at the same levels as before the price surge, and there have been limited company-specific improvements that would significantly impact profitability.

Conclusion

I really like ADM as a company. It is not easy to establish vast global connections and gain access to facilities and farms to produce and sell a wide range of agricultural products.

I think this company will continue to be one of the most stable and could benefit from population growth. However, there is a risk that the downward trend in sweetener use and the impact of weight-loss drugs will reduce long-term profitability.

With agricultural commodity prices normalizing after the initial rise due to the Russia-Ukraine war, I expect ROA to return to historical levels. The market already recognizes this, since the stock trades at an adjusted P/B of 1.2x, up from 1.8x in 2022. The price seems precise enough to give us no alpha.

Given the fair pricing and near-term headwinds I expect, I reiterate my “Hold” rating for Archer-Daniels-Midland.