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Archer-Daniels-Midland Company (ADM)

Founded in 1898, Archer Daniels Midland (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. Archer Daniels Midland maintains a robust network of processing plants, storage facilities, and transportation vehicles around the world to run its business efficiently.

Source: Archer Daniels Midland Investor Presentation
The company has four main business segments:

  • Oilseeds Processing (37% of sales, 31% of operating profits): 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 (15% of sales, 34% of operating profits): 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).

  • Agricultural Services (43% of sales, 22% of operating profits): utilizes ADM's 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 (4% of sales, 11% of operating profits): one of the world’s leading flavors and specialty ingredients companies thanks to ADM's acquisition of 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 (1% of sales, 2% of operating profits): financial services.

Business Analysis

ADM has been in business for more than 100 years and will likely outlive all of us. At the end of the day, the basic investment thesis for food companies such as Archer Daniels Midland is simple: everyone has to eat. That’s especially true with a growing global population and with faster-growing emerging markets (such as China) whose middle classes are increasingly consuming more Western-style diets.

Specifically, that means more corn-based products and meat, which is highly grain intensive (that’s what livestock is fed). 

Archer Daniels' core operations – procuring, storing, processing, and selling various agricultural commodities – are also extremely capital intensive, creating somewhat high barriers to entry. 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 Archer Daniels 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 Archer Daniels' 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, Archer's regulatory-driven ethanol business, a strong U.S. dollar, volatile crop prices, and the recent plunge in oil prices highlight some of the struggles ADM’s business can face.

Perhaps unsurprisingly, Archer Daniels 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. 

Starting in 2012, management initiated a long-term turnaround plan that involved two main strategies. First, ADM would sell off non-core businesses (i.e. those with the lowest margins) and reallocate the capital into acquiring a number of higher-margin businesses, specifically those in specialty foods products.

ADM sold its chocolate business for $440 million and its cocoa business for $1.2 billion in 2015. Analysts estimated 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 Archer Daniels' total sales (around 10% of profits), the $50 billion specialty ingredients industry is a space known for its customer loyalty and solid profitability.
Source: Archer Daniels Midland Investor Presentation

Management's second strategy is to leverage the company’s world-spanning supply chain and large capital resources to launch numerous specialty products, which management believes can achieve at least $1 billion in new annual sales.
Source: Archer Daniels Midland Investor Presentation
Finally, and perhaps most importantly in a commodity industry such as this, management is focused on achieving large-scale cost reductions through numerous avenues, including synergies with the company's recent acquisitions. In fact, between 2013 and 2019 Archer Daniels hopes to cut over $1 billion in annual costs.
Source: Archer Daniels Midland Investor Presentation
Overall, it’s hard not to like the transition Archer Daniels Midland is making, and its set of hard assets is very difficult to replicate. When combined with management's conservative capital allocation plans, the company has been able to increase its dividend for more than 40 consecutive years, despite its cyclicality. 

However, the number of uncontrollable macro factors the company depends on for pricing many of its products and generating an acceptable return is still a major risk.

Key Risks

While Archer Daniels Midland is generally a low-risk dividend growth stock, there are still several concerns for investors to consider.

First and foremost is that Archer operates in a highly competitive field. In fact, while its scale is large, it has several sizable rivals, including Bunge Limited (BG). And since Archer Daniels is essentially a middleman between farms and consumers, it does not have much pricing power.

As a result, the company's sales, earnings, and cash flow are driven by factors largely out of its control, including the weather, commodity prices (especially the prices of soybeans, corn, and oilseeds), and government agricultural policies.

For example, in 2011 and 2012 the severe drought in the U.S. resulted in far less demand for food processing (due to crop failures) and surging crop prices, which ADM was not able to fully pass on to downstream markets. As a result, the drought had a large negative impact on the company's operating profits.
Source: Archer Daniels Midland Investor Presentation
Another risk is U.S. agricultural policy, specifically corn subsidies and ethanol mandates, which have resulted in corn becoming Archer’s largest and most important product over the past few decades. 

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, government subsidies are still a big help for the company. Any future reversal of these subsidies or decreased ethanol mandates (which cost U.S. consumers $6 billion a year in higher gas costs, according to the Center for Science in the Public Interest) could leave Archer in an uncomfortable position, having to once again restructure its fundamental business model.

And it’s not just U.S. government policy that is a risk. Remember that Archer operates globally, which means that its long-term plans to diversify internationally need to be approved by foreign regulators, something that is far from certain.

For example, back in 2013 Australian regulators blocked the company’s attempted $3.1 billion acquisition of GrainCorp stating that it was “not in the national interest”.

That decision came as a huge surprise to industry analysts, especially given the favorable economic relationships between the U.S. and Australia, as well as ADM’s various promises to help win support for the deal. That included investing $200 million into expanding Australia’s grain export infrastructure (Australia is the world’s 3rd largest grain exporter behind the US and Canada) and limiting annual increases in silo fees.

Overall, ADM’s strong ties to uncontrollable macro factors such as global crop prices, government subsidies (e.g. ethanol), and shifts in consumer preferences (away from sweeteners and starches) results in above-average business risk. 

The company is financially healthy and has a massive asset network that is 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?

Closing Thoughts on Archer Daniels Midland

Archer Daniels Midland, despite its dividend aristocrat status, ultimately depends on a number of factors outside of the company’s control – corn and soybean prices, oil prices, ethanol regulations, and government subsidies.

While management appears to be making the right capital allocation moves to gradually diversify the company into higher-returning areas that are less susceptible to swings in commodity prices, these actions also suggest that management might be less optimistic about some of Archer Daniel’s existing operations.

With that said, the company’s dividend appears to remain very safe and offers reasonable growth prospects, but shareholders ultimately need to be optimistic about macro conditions and ethanol mandates remaining favorable. At the end of the day, ADM seems more like a trading stock rather than a core long-term investment - even despite its quality management team and strong balance sheet.

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