Archer Daniels Midland: The World Needs To Eat
Illinois based Archer Daniels Midland Company (ADM) traces its roots back over 110 years to a partnership between George Archer and John Daniels in 1902; their business was to crush linseed. After working together for 21 years they acquired Midland Linseed Products Company and the Archer Daniels Midland Company as it is known presently was formed.
Today the company employees more than 30,000 people worldwide who work in 265 processing plants and more than 460 sourcing facilities. Archer Daniels Midland's business is to trade, transport, store and process corn, oilseeds, wheat and cocoa into products for food, animal feed, industrial and energy uses. In 2012 the company had sales over $90 billion - that's a lot of food processing. Essentially, Archer Daniels works as a middleman between farmer and consumer.
One of the more compelling things about this company is its rigid propensity to continuously reward shareholders. Most to this point was the board of director's recent decision to increase its dividend by 26% last month. On its own this would be impressive, but it is even more remarkable given the fact that Archer Daniels has not only paid but also increased its dividend for 39 straight years.
Additionally, one of our previous articles alluded to the long-term potential of the world's food needs. Specifically, research into John Deere (DE) gave us the following bit of forward thinking:
"Macro-economic tailwinds are at our backs. By 2050, the world's population is expected to expand to 9 billion people. We're at more than 7 billion today. That growth will come mostly from emerging economies, such as China and India, where incomes are increasing, and diets improving. An increased demand for food, fuel, and fiber will require an approximate doubling of agricultural output in that timeframe."
Much in the same manner that Deere argued there is a need for more efficient agriculture, it stands to reason that a growing population will unremittingly demand more food. Or expressed more succinctly: the world needs to eat. In turn, it follows that Archer Daniels' business model appears quite sustainable; or as the company would describe its place in the world:
"We produce the food ingredient, animal feeds and feed ingredients, biofuels and other products that manufactures around the world use to provide wholesome food and a better life to millions of people around the globe."
It's clear that they provide a vital service. Yet none of this is to suggest that the company is without risks. In fact, Morningstar analyst Jeffrey Stafford assigns Archer Daniels with a "no-moat" rating. Specifically, he indicates:
"As one of the four dominant players, Archer Daniels Midland holds a solid position in global agribusiness. The company owns a massive network of processing plants, storage facilities, mills, port operations, and transportation options that would be difficult to replicate from scratch. That said, the capital intensity of Archer Daniels' operations and the generally razor-thin margins generated in agribusiness have historically made it difficult for the company to generate returns on invested capital above our estimated cost of capital. We don't believe the company holds a sustainable cost advantage in any of its businesses, and Archer Daniels' commodity products are not differentiated enough to create customer switching costs."
In other words, much unlike a Coca-Cola (KO) or Johnson & Johnson (JNJ) the company can't simply state "our competitors are charging X for linseed, ours is worth 1.2X." The operations are commodity driven and cannot be easily differentiated. Yet this doesn't mean the company is unprofitable - in fact Archer Daniels' record of profitability is especially compelling.
Below we have included the Earnings and Price Correlated F.A.S.T. Graph™. Here we see that Archer Daniels has grown operating earnings (orange line) by just over 14% per year over the last decade and a half - with just two down years. As described, the dividend (pink line and blue shaded area) has been especially consistent. Finally, today shares of Archer Daniels trade at about 14 times earnings against a normal P/E (blue line) of about 15 times earnings.
Given this strong earnings growth rate, one might expect performance results to be quite solid as well. Below we have included the 15-year Performance Results table. An investor in Archer Daniels over the last 15 years would have received an annual compound return of 10.6% a year - as compared to a 2.5% yearly return for the S&P 500 index. During this time one would have also collected roughly 2.7 times the amount of dividend income as the index as well. A hypothetical $10,000 investment at the end of 1999 would now be worth over $41,000 without reinvesting dividends. Finally, notice that while the performance results are quite good, they still trail the operating results of the business. This is a direct result of the P/E ratio dropping from about 25 at the turn of the century to today's mark closer to 14.
Given these facts, it might be useful to look toward the potential future prospects of the business. By using the Estimated Earnings and Return Calculator, we can see how analysts are presently viewing this company. Fourteen analysts reporting to S&P come to an estimated earnings growth rate of 10%. In double checking with analysts reporting to Zacks, this number appears reasonable. If earnings materialize as forecast and Archer Daniels is trading at 15 times earnings in the future, this would translate to a 5-year annualized total return of 14.7%.
Now, it's paramount to consider the idea that this is simply a calculator. More specifically, it defaults to the consensus analysts' estimates for the next two fiscal years and then uses the estimated earnings growth rate to project into the future. Additionally, the dividend payout ratio is assumed to stay constant and thus grows in line with expected earnings growth. F.A.S.T. Graphs' subscribers have the ability to change these assumptions to fit their own expectations or scenario analysis. However, as it stands, it generally provides a very solid baseline for how analysts are thinking about the company.
Overall we have found Archer Daniels to be a historically strong company with a great record of consistently rewarding shareholders. Moreover, the demand for this service appears to be quite sustainable for decades, if not centuries. Yet that's not necessarily to suggest that Archer Daniels will be the clear runaway winner in the industry. Commodity driven businesses are subject to wide fluctuations in both price and competitor strategy. Nevertheless, Archer Daniels has a history of providing solid returns in an otherwise standard business. At its current valuation, if earnings materialize, we find Archer Daniels to be relatively attractive in respect to both its historical valuation and future prospects. However, as always, we recommend that the reader conduct his or her own thorough due diligence.
Disclosure: Long KO, JNJ at the time of writing.