ADM’s stock sits near its 52-week low price and yields 3.1% after falling by more than 30% over the past year. Whenever we see dividend aristocrats such as ADM in these situations, we get excited – perhaps an excellent business is now on sale for long-term investors.
After all, ADM has been around for more than 100 years and is a critical piece of the US agricultural landscape. People will keep eating, and volatile commodity prices will eventually return to more favorable levels. Right?
Probably. However, after a closer inspection of the business, we uncovered several factors that complicate ADM’s investment case. In the research below, we analyze ADM’s business and evaluate its appropriateness for our Top 20 Dividend Stocks Portfolio.
ADM procures, transports, and processes corn, oilseeds, wheat, and other commodities into products for food, beverage, animal feed, chemical, and energy uses around the world. The company’s end products include vegetable oil, protein meal, flour, corn sweeteners, starch, ethanol, and many other food and feed ingredients. ADM maintains a robust network of processing plants, storage facilities, and transportation vehicles around the world to run its business efficiently.
ADM’s segment mix using pro-forma operating profit in 2014:
- Oilseeds Processing (35%): processes soybeans and soft seeds into vegetable oils and protein meals. These products can be sold “as is” or further processed into salad oils, margarine, and more.
- Corn Processing (30%): converts corn into sweeteners, starches, and bioproducts. Sweeteners include high-fructose corn syrup (HFCS), which is used in products such as soft drinks, cereals, bread, and other products because it is more affordable than sugar. Starches are also used in food production and as feedstocks for ADM’s bioproducts operations (ethanol).
- Ag Services (24%): utilizes its U.S. grain elevator, global transportation network, and port operations to buy, store, clean, and transport agricultural commodities, such as oilseeds, corn, wheat, milo, oats, rice, and barley, and resells these commodities primarily as food and feed ingredients and as raw materials for the agricultural processing industry.
- Wild Flavors & Specialty Ingredients (9%): one of the world’s leading flavors and specialty ingredients companies. ADM acquired Wild Flavors for $3 billion in 2014. Wild Flavors’ products include flavors, colors, sweeteners and health ingredients as well as ready-to-market concepts and complete solutions. SCI is a leading originator, processor and distributor of healthy ingredients, including nuts, fruits, seeds, legumes and ancient grains.
- Other (2%): financial services.
ADM has been in business for more than 100 years and will likely outlive all of us. People will continue needing to eat many of the foods and beverages that use ADM’s products, and we expect the company to continue using its cash flow to diversify away from lower value, commodity-sensitive businesses such as ethanol.
ADM’s core operations – procuring, storing, processing, and selling various agricultural commodities – are extremely capital intensive. The company has the largest grain terminal and shipping network in the country and maintains hundreds of processing plants and storage facilities around the world.
These capabilities allow ADM to be the lowest cost and fastest provider of its commodities and processed products to many customers’ facilities, where it delivers directly. Replicating ADM’s physical footprint; thousands of trucks, trailers, tank cars, river barges, towboats, and vessels used to transport its products; and its logistical knowledge would be nearly impossible. With razor-thin operating margins in the commodity industry, there is no room for inefficiencies.
While ADM’s existing businesses will continue generating cash flow for a long time to come, it seems that the company’s management team recognizes that the company’s high sensitivity to commodity prices isn’t ideal. The 2012 drought, regulatory-driven ethanol business, strong US dollar, volatile crop prices, and recent plunge in oil prices highlight the struggles ADM’s current business faces.
Perhaps unsurprisingly, ADM is gradually shedding low-return operations and moving into areas of higher value in an attempt to structurally improve its return on capital and remove some of the price sensitivity of the business. ADM recently agreed to sell its chocolate business for $440 million and its cocoa business for about $1.2 billion. Analysts estimate that these assets were worth $3 billion but were barely generating returns above breakeven.
In July 2014, ADM announced an acquisition of natural ingredient company Wild Flavors for $3 billion, helping it diversify into higher-return areas and better align itself with consumers’ desire for foods with natural ingredients and flavorings. While this is a relatively small portion of ADM’s total sales, we like the specialty ingredients industry and own International Flavors (IFF) in our Long-term Dividend Growth portfolio.
In addition to the ongoing shift in portfolio mix, ADM targets $550 million in additional run-rate savings by 2020. Altogether, ADM’s goal is to increase its return on invested capital (ROIC) beyond 10%:
We like the transition ADM is making and believe its set of assets is very difficult to replicate. However, we don’t like the number of uncontrollable macro factors the company depends on for pricing many of its products and generating an acceptable return.
Most of ADM’s businesses are sensitive to crop prices. When the price of soybeans, corn, and oilseeds fluctuate, companies such as ADM typically raise and lower product prices in line with underlying commodity costs. During periods of rapidly rising costs, such as the drought of 2011-12, ADM isn’t able to fully pass through higher prices to downstream markets, hurting profitability.
When input prices fall, however, some end products have stickier pricing than others and allow for margins to expand – ADM’s costs fall more than its selling prices. ADM has long-term contracts with suppliers to help smooth out revenue relative to more volatile commodity prices, but the pricing of many of its products does follow input cost movements and can also be impacted by currency exchange rates.
While crop prices will ebb and flow, one of the biggest risks facing ADM, in our view, is the amount of government support the company receives. Government policies and regulations can significantly impact agricultural production and trade flows, influencing many areas of ADM’s business.
According to a 1995 report by the libertarian think tank Cato Institute, “ADM has cost the American economy billions of dollars since 1980 and has indirectly cost Americans tens of billions of dollars in higher prices and higher taxes over that same period. At least 43 percent of ADM’s annual profits are from products heavily subsidized or protected by the American government. Moreover, every $1 of profits earned by ADM’s corn sweetener operation costs consumers $10, and every $1 of profits earned by its bioethanol operation costs taxpayers $30.”
A lot has changed since 1995, including ADM’s mix. However, there are still obvious signs of government support helping the company. For example, ADM reported R&D expenses, net of reimbursements of government grants, of a mere $79 million in 2014, representing a tiny fraction of the company’s $81 billion in sales. To put this in perspective, most companies spend at least 1-2% of sales on R&D, which would amount to $810 million to $1.6 billion each year – 10-20x ADM’s realized expense.
ADM’s ethanol operations, which accounted for 18% of total segment operating profits last year, are perhaps the biggest regulatory beneficiary. According to the Center for Science in the Public Interest, “Subsidies to companies that blend corn ethanol into gasoline, coupled with a mandate to market billions of gallons of that gasoline annually, cost taxpayers $6 billion a year. Using corn for fuel leads to higher prices for corn and foods with corn ingredients…”
The EPA has proposed to reduce the minimum required volume of corn-based ethanol in gasoline in 2015 and 2016 across the country, below an earlier congressional target for each year. Ethanol’s environmental effects have increasingly been challenged in Washington as well.
The ethanol business does benefit from strong international demand, but it seems likely to remain volatile with an increasingly uncertain future in the US. ADM’s ethanol business saw operating profits drop by 78% in the third quarter as lower oil prices hurt the selling prices of ethanol and biodiesel. The importance of ethanol to ADM’s profit growth should continue declining as the business diversifies into other areas, but it does seem like a risk to be aware of over the next few years, especially as the EPA continues to influence the domestic market.
Finally, in addition to crop price sensitivity and government subsidies, shifting consumer preferences could erode demand in some of ADM’s downstream food and beverage markets. Sweeteners and starches accounted for 12% of ADM’s total segment operating profits last year.
While these products are not huge profit contributors, they are still meaningful. Consumers are becoming increasingly critical of foods and beverages containing unhealthy ingredients such as high-fructose corn syrup and genetically modified crops. ADM will need to continue producing new types of products that are better aligned with trends such as organic eating.
Overall, ADM’s strong ties to uncontrollable macro factors such as global crop prices, government subsidies (e.g. ethanol), and shifts in consumer preferences results in above-average business risk, in our view. The company is financially healthy and hard to replicate, but predicting its earnings over the next few years is a challenge – what will happen with ethanol regulation? Will oil prices recover? Where will soybean prices head?
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. ADM’s long-term dividend and fundamental data charts can all be seen by clicking here and support the following analysis.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
ADM recorded an excellent Safety Score of 90, suggesting its current dividend payment is safer than 90% of other dividend-paying stocks in the market. The company’s moderate payout ratios, strong balance sheet, decent cash flow generation, and wide moat support the favorable ranking despite ADM’s sensitivity to commodity prices.
Over the trailing twelve months, ADM’s dividend has consumed 39% of its GAAP earnings and 78% of its free cash flow. These are healthy ratios, especially considering the difficult market environment ADM has dealt with over the last year.
Looking at longer-term trends in payout ratios can also be helpful to see if growth in earnings per share has kept up with dividend growth. As seen below, ADM’s payout ratios have remained below 40% for most of its history. The spike in 2012-13 was driven by draught-related weakness, which temporarily crimped ADM’s profitability.
Source: Simply Safe Dividends
For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis. ADM’s reported sales fell 1% in fiscal year 2009, and its earnings dropped by 5%. Sales fell another 11% in fiscal year 2010 on lower crop prices, but earnings actually grew 15% on ethanol-related strength. If nothing else, these results highlight the importance agricultural prices have on ADM’s business – more so than how the global economy is doing.
Blue chip dividend stocks are able to generate free cash flow year in and year out. Rising cash flow is important because it supports continued dividend growth without expanding the payout ratio. As seen below, ADM’s free cash flow generation has been a bit spotty because its business is very capital intensive – grain elevators and transportation networks are costly to build out but last for decades. ADM should remain a cash cow, barring any extreme shocks to agricultural prices.
While payout ratios, margins, industry cyclicality, free cash flow generation, and business performance during recessionary conditions help give us a better sense of a dividend’s safety, the balance sheet is an extremely important indicator as well. Companies with high amounts of debt, cyclical business operations, and inconsistent cash flow generation could find themselves in a cash crunch if demand unexpectedly weakens and they have overextended themselves. They will always cut the dividend before missing a debt payment, so monitoring cash and debt levels is important, especially for macro-sensitive businesses such as ADM.
As seen below, ADM has moderately reduced its debt to capital ratio since fiscal year 2009 and ended last fiscal year at a very healthy ratio of 22%. We typically like to see levels less than 50% for average businesses, and ADM looks good given the cyclical nature of its business. It should maintain less debt to account for the unexpected – swings in oil prices, corn prices, ethanol demand, etc.
Taking a closer look at ADM’s balance sheet, we can see the company has more cash and investments on hand than it does total book debt ($6.3 billion versus $5.8 billion). The company’s free cash flow last year ($4.5 billion) covered its dividend payment ($624 million) by a factor of 7x. ADM is in great shape to continue paying and growing its dividend.
Altogether, ADM’s dividend is extremely safe. The company’s payout ratios are reasonable, the business generates dependable free cash flow, and the balance sheet is in great shape. Even if commodity prices weaken further, it’s hard to imagine a scenario that endangers ADM’s dividend.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
ADM’s Growth Score is 44, meaning its dividend’s growth potential ranks higher than over 44% of all other dividend stocks we monitor. The company has grown its dividend for 40 consecutive years, easily securing its status on the list of dividend aristocrats.
As seen below, ADM’s dividend increased has increased at a double-digit annual rate over every period over the last decade. Until sales growth and earnings stabilize, near-term dividend growth could come in below recent increases since ADM targets paying out 30-40% of earnings as a dividend.
ADM trades at 13.2x next year’s consensus earnings estimates, reflecting the macro headwinds impacting most aspects of its business. ADM’s dividend yield is 3.1%, above the market’s average.
What could go wrong from here? If oil prices remain low and crop prices spike up, ADM’s profitability could be squeezed, particularly within its ethanol operations. This business lost money during the drought in 2012, and the stock fell into the mid $20s (trades at $36 today).
Otherwise, unfavorable news from the ongoing review of the Renewable Fuel Standard could hurt US ethanol demand over the coming years. ADM has a growing ethanol export business, but it’s probably not enough to offset an unfavorable domestic trend.
It’s hard to get comfortable with a sustainable earnings growth rate for ADM going forward because of all of the macro sensitivities the business has. The more diversified and higher returning ADM we will hopefully see by 2020 sounds more attractive, but there will likely be a number of bumps along the way.
More optimistic investors might point to ADM’s 5% earnings per share CAGR over the last five years and argue that the stock already offers 8-10% per year total return potential going forward even if its 13x earnings multiple doesn’t increase.
We would be more interested in the stock if it traded down into the mid $20s and generally prefer companies with high barriers to entry and better pricing power with less macro sensitivity. ADM seems to lack the latter.
ADM’s fate depends on a number of factors outside of the company’s control – corn and soybean prices, oil prices, ethanol regulations, and government subsidies. Management appears to be making the right capital allocation moves to gradually diversify ADM into higher-returning areas that are less susceptible to swings in commodity prices. The 2014 acquisition of Wild Flavors and recent divestitures of its low margin coca and chocolate businesses are examples.
However, these actions also suggest that management might be less optimistic about some of ADM’s existing operations. For a company with such high reliance on commodity prices and government subsidies, we need to maintain an especially high bar.
The dividend looks very safe with reasonable growth prospects for investors living off dividends in retirement, but shareholders need to be optimistic about macro headwinds bottoming out and ethanol mandates remaining favorable. We are less comfortable with these risks but will continue watching ADM for a bargain price over the next year.