Archer-Daniels-Midland: Appears Undervalued, But May Be Just A Value Trap (NYSE:ADM)

Archer-Daniels-Midland Company (NYSE:ADM) engages in the procurement, transportation, storage, processing, and merchandising of agricultural commodities, ingredients, flavors, and solutions in the United States and internationally.

The firm has just reported its quarterly results recently, so we thought it is time to give an updated view on the overall business performance and on the valuation.

We have started covering the stock back in July 2022, and since then, all our analysis resulted in a neutral view. Each time, we have highlighted the attractiveness and the sustainability of the dividend, but we have raised concerns with regards to valuation.

The aim of our article today is to discuss, whether the current share price and the latest results warrant a more bullish/more bearish rating or not.

As we have always started our writings with a view on the valuation, we will also do so now, using a dividend discount model and a set of traditional price multiples.

Valuation

Dividend discount model

In our previous writing, we have determined the fair value of ADM’s stock to be about $56. This figure is a result of an assumed dividend growth rate of 12.5% in the next five years, based on the most recent dividend growth rate of the firm, which was followed by a 2.5% growth in perpetuity. Our required rate of return for this calculation was 8.25%, equivalent to the firm’s weighted average cost of capital (WACC) at that time.

To assess, whether the $56 is still valid, we have to first understand, if the input parameters to our model are valid or not.

Let us first take a look at the WACC. The following table shows the latest estimate of ADM’s weighted average cost of capital. We can see that due to the lower cost of equity, as well as the lower cost of debt, ADM’s cost of capital has gone down significantly, to 6.7%. This is likely to have a positive impact on our fair value calculation.

On the other hand, however, the firm’s dividend growth has started to slow.

Assuming a 12.5% dividend growth in the current market environment is most likely way too aggressive. Even the TTM dividend growth rate of 11.8% seems too high. To stay somewhat more realistic and also take into account the declining revenue, we will use the firm’s 5Y CAGR dividend growth rate of 6.8% for the next five years, and use 2.5% growth in perpetuity, just like before.

The updated input parameters yield a fair value of $61 per share, which is currently roughly 5% above the share price.

We also have to highlight that ADM has reiterated its commitment to return value to its shareholders both through dividends and share buybacks. And for this reason, we believe that going forward using a dividend discount model is a valid approach.

Let us take a look at the valuation from a different perspective, by looking at a set of traditional price multiples.

Price multiples

The following table summarises ADM’s valuation metrics and compares them with the consumer staples sector median, as well as with the firm’s own historic averages.

Based on these metrics, ADM’s stock also appears to be trading at a discount. The valuation right now appears attractive both compared to the sector median and also compared to the firm’s own historic metrics.

If we narrow down the comparison to a peer group consisting only of firms in the Agricultural Products industry, we can see that ADM is actually one of the cheapest ones – at least among those that have generated positive earnings.

We believe that ADM’s stock appears to be right now attractive from a valuation point of view, based both on its dividend and also on a set of traditional price multiples. Let us look at the latest results and the key takeaways from there, to assess whether it is really a value play or just a possible value trap.

Quarterly results highlights

In the most recent quarter ADM has missed analyst estimates both top- and bottom line. The firm’s revenue came in at $22.25 billion, almost 12% lower than in the prior year and $940 million below initial estimates. ADM’s earnings have totalled in $1.03 per share, $0.21 below expectations.

These misses are quite significant and not just marginally below expectations.

Let us see what have been the primary factors driving this poor performance.

1. Ag Services & Oilseeds

This segment has had a lot of struggles in the most recent quarter:

• The amount of soybean crop has been lower than expected
• Logistics cost came in above expectations
• Downward pressure on margins, primarily due to less trading opportunities
• Lower global soy crush margins

In our view, these struggles are not related to the efficiency of the business itself. Most of these headwinds are generated by the global markets.

That being said, we would recommend being cautious as it may take several quarters for the industry to see improvements, especially in the current macroeconomic/geopolitical environment.

2. Nutrition segment

The nutrition segment paints a slightly different picture, however. In this segment, we can also see a significant decline in the operating profit, but it was driven by factors related more closely to the operation itself. E.g., the unplanned downtime at the Decatur East facility costed the firm roughly $25 million. Increased manufacturing costs have also created further headwinds, which could only be partially offset by the higher volumes and higher margins in the animal nutrition sub-segment.

Although in this case, the decline is driven by the operating performance, we believe that this downtime is not likely to be recurring and therefore we expect these results to be slightly better in the coming quarters.

3. Outlook

Looking ahead, we can see that the company expects a significant decline in the EPS for the full year compared to 2023. Increased corporate costs, along with higher interest expenses are all creating headwinds.

For these reasons, we still believe that caution is warranted and despite the more attractive valuation now, we would like to see a higher margin of safety before we could assign ADM a more bullish rating.

Conclusion

After updating the input parameters to our dividend discount model, we estimated ADM’s fair value to be roughly $61 per share. This assumes a required rate of return of 6.7% (equivalent to the firm’s weighted average cost of capital) and a dividend growth rate of 6.8% in the next five years and 2.5% in perpetuity.

According to a set of traditional price multiples ADM also appears to be undervalued.

ADM, however, has missed analyst estimates both top- and bottom line in the most recent quarter, with revenue declining as much as 12% YoY. The Ag services & oilseeds, along with the nutrition segment have performed the worst.

Because of the weak outlook and the poor recent performance, we believe a “buy” rating is still not justified, despite the apparent undervaluation.