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.
Business Overview
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.
Business Analysis
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 & Fragrances (IFF) in one of our dividend portfolios.
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 beyond 10%:
Source: ADM Investor Presentation
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.
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