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Archer-Daniels-Midland Offers a Favorable Risk-Reward

·6 mins read

- By Nathan Parsh

Shares of Archer-Daniels-Midland Company (NYSE:ADM) are up more than 19% since I last looked at the company in May, outperforming the 12% gain in the S&P 500 over this time.

Even after this return, I feel that Archer-Daniels-Midland still offers a total return of almost 10% before the stock gets above the high end of my valuation range. Let's take a look at why.

Recent earnings results

Archer-Daniels-Midland reported second quarter results on July 29. Revenue of $16.3 billion was essentially flat year over year, though this was $164 million lower than what analysts following the company had expected. Where the company really shined was in its profit results. Earnings per share increased 25 cents, or 42%, to 85 cents. This was 34 cents above what the market had anticipated. This growth was despite an effective tax rate of 14% compared to 13% in the prior year.

The average number of shares was down 4 million, or less than 1%, so the improvement in profits came mostly from improved business performance. Segment operating profit was up $168 million to $813 million.

Much of the gain in EPS was due to the Agricultural Services & Oilseeds segment. This segment had 14% profit growth, but the real star was the Ag Services business, which nearly doubled.

The company's South America business was the primary driver of growth as this region had record quarterly origination and export volumes. Weakness in the Brazilian Real coupled with higher selling by farmers resulted in meaningful improvements in margins as well.

Also helping results was the increased buying of food by countries ahead of the pandemic.

On the other hand, lower grain margins in North American were a headwind in the quarter. Crushing was down in this region as well (crushing demand was solid in all other regions). Better biodiesel volumes and margins in the Americas regions helped lead to better performance in Refined Products.

Nutrition also performed well with profit growing 35% year-over-year. Human Nutrition was higher by 27% while Animal Nutrition more than doubled. In Human Nutrition, the company saw a favorable mix and margin gains in North America. Archer-Daniels-Midland saw higher demand for plant-based proteins and edible beans in its Specialty Ingredients business. Fiber and additional fermentations had better volumes and margins. Pet food and treats growth continues to accelerate, which was the primary driver of gains in the Animal Health business.

Carbohydrate Solutions inched higher by less than 2% as gains in Corn Processors were offset by declines in Starches and Sweeteners. North America experienced a material drop in food service demand and mark-to-market losses on corn oil contracts. Partially offsetting these declines were lower raw material costs and better risk management results. Wheat milling was once again a strong point for Archer-Daniels-Midland as retail demand remained elevated and optimizations initiatives proved fruitful. Vantage Corn Processors benefited from higher prices and margins for industrial ethanol even as production fell due to fewer miles driven.

Current assets totaled $44.3 billion at the end of the second quarter, with $1.2 billion of cash and equivalents. This was a lower cash balance than the previous quarter. Total debt was down to $9.4 billion from $12.7 billion at the end of the first quarter of 2020. The company has just $541 million of debt due within a year.

Archer-Daniels-Midland's revenues may have been flat for the quarter, but the company's ability to squeeze additional profits out is a sign of a well-managed business. Food Service will likely benefit as restrictions are eased as well. Restrictions related to Covid-19 in North America limited demand from restaurants, but most of the remaining business were solid. Ethanol revenues could also grow as industrial demand returns. Nutrition also remains a solid source of growth for the company.

In short, the company had a good quarter and has room for improvements in several areas.

Valuation analysis

The last time I looked at Archer-Daniels-Midland, the average analysts' estimates called for EPS of $2.95 for 2020. This number has since been raised slightly to $3.07 according to Yahoo finance.

Archer-Daniels-Midland had an average price-earnings ratio of 15 over the last decade. As a result, I have a target valuation range of 14 to 16 times earnings for the stock. Shares of the company have a forward price-earnings ratio of 15 based off of analyst estimates and Wednesday's closing price of $46, which is right in the middle of my target range.

Applying analysts' estimates for EPS for this year results in a price target range of $43 to $49. This means that Archer-Daniels-Midland's stock has both a downside and upside of 6.5%.

Also included in total returns would be the stock's dividend yield. Using the annualized dividend of $1.44, shares pay a 3.1% yield today. The yield would be 3.3% at the low end of the price target range and 2.9% at the high end of the price target range. Total returns using valuation and dividend yield would then range from a loss of 3.2% to a gain of 9.4%, which is arguable a solid risk-reward.

This is before Archer-Daniels-Midland raises its dividend, something the company has down for 45 consecutive years. If the company sticks to its usual schedule, the dividend increase announcement should come in early November and will likely be for a penny.

Final thoughts

Archer-Daniels-Midland has been a solid performer since the end of May. While much of the return that I believed was possible has occurred, shares still offer a total potential return of more than 9%. Most of the company's businesses are showing signs of growth and the few that aren't will likely perform better as Covid-19 retreats in North America

Archer-Daniels-Midland has been a steady performer over all phases of the economic cycle, which has allowed the company to grow its dividend for more than four decades. Shares also offer an above market average yield.

Investors still looking for an entry point into Archer-Daniels-Midland should consider the stock's risk-reward as very favorable. I continue to believe that the stock can be bought even after recent gains.

Disclosure: the author has no position in Archer-Daniels-Midland Company

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This article first appeared on GuruFocus.