The Case for Archer Daniels Midland

Posted on 17/11/2010

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A recent post applied the quantitative principals used by Benjamin Graham to the US in order to seek-out large-capitalisation companies that may present attractive investment opportunities.  One of the companies that came-up was Archer Daniels Midland (“ADM”), a food-processing business that earned revenue and net income of $61.6bn and $1.9bn in FY10 and a market-capitalisation of $18.9bn.

Google Finance describes Archer Daniels Midland as follows:  “Archer Daniels Midland Company is principally engaged in procuring, transporting, storing, processing, and merchandising agricultural commodities and products. It is a processor of oilseeds, corn, wheat, cocoa, and other agricultural commodities and is a manufacturer of vegetable oil and protein meal, corn sweeteners, flour, biodiesel, ethanol, and other food and feed ingredients. The Company also has a grain elevator and transportation network to procure, store, clean, and transport agricultural commodities, such as oilseeds, corn, wheat, milo, oats, and barley, as well as processed agricultural commodities. The Company’s operations are classified into three business segments: Oilseeds Processing, Corn Processing, and Agricultural Services. The Oilseeds Processing segment includes activities related to the origination, merchandising, crushing, and further processing of oilseeds. Corn Processing segment is engaged in corn wet milling and dry milling activities.”

The company also owns 16% of Wilmar International Ltd, a Singapore-listed food-processing company with significant operations across Asia.  ADM’s stake in Wilmar is currently worth S$6.5bn, or US$4.9bn.  Stripping-out this investment from our analysis of ADM suggests that the core business is currently trading at an enterprise value of $17bn, compared to LTM EBITDA of $4.5bn, a multiple of 3.8x.  The company has an unbroken record of increasing the dividend since Feb-88, with the yield currently standing at 2.02%, though share buybacks take the annual cash return to shareholders to 2.6%.  The current free cash flow yield (based on FY10 numbers) is 5.7%, while the price/book ratio is 1.3x.

The disadvantages/risks of investing in ADM are as follows:

  • Gross margins are relatively low (6.2% in FY10) are quite variable (5.4% in FY08 vs 7.3% in FY07), leading to significant movements in absolute earnings from year-to-year.
  • Working capital has historically been highly volatile, with some periods seeing significant cash outflows.  However, the strength of the balance sheet should be sufficient to withstand this.
  • Capital expenditure has been very high in recent periods, leaving residual cash flow either negligible or negative.

I would feel that with an increasing global (and US) population, increasing demand for meat (particularly in Asia), and continuing industrialisation of the global food-chain, the company should continue to see revenue and earnings growth over the medium-term, albeit with a reasonable level of volatility in the short-term.  Given the essential nature of ADM’s product-base, the company’s low level of indebtedness, the strong dividend record and low valuation, I think ADM presents a potentially attractive investment opportunity for the long-term, albeit one likely to deliver steady rather the stellar returns.

Cautious Bull does not currently own any shares in Archer Daniels Midland.

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Posted in: Investment Ideas