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Archer-Daniels-Midland: 43 Straight Years of Dividend Increases

Founded in 1898, Archer Daniels Midland (ADM) procures, transports, and processes corn, oilseeds, wheat, and other commodities which are turned into products for food, beverage, animal feed, chemical, and energy uses around the world.

The firm's end products include vegetable oil, protein meal, flour, corn sweeteners, starch, ethanol, and many other food and feed ingredients.
Source: Archer Daniels Midland Investor Presentation

Archer Daniels Midland has an extensive global network of over 750 processing, distribution, and storage facilities, which it uses to efficiently transport and process various commodities and products for customers around the word. 
Source: Archer Daniels Midland Investor Presentation
The company operates through four main business segments:

  • Oilseeds (44% of operating profit): 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. In total, oilseeds are used in over 60 final food products sold around the world. 

  • Origination (16% of operating profit): utilizes its extensive global grain elevator and transportation networks 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.

  • Carbohydrate Solutions (28% of operating profit): converts corn and wheat into sweeteners, starches, wheat flour, 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). ADM is the largest corn processor worldwide.

  • Nutrition (10% of operating profit): engages in the manufacturing, sale, and distribution of specialty products including natural flavor ingredients, flavor systems, natural colors, proteins, emulsifiers, soluble fiber, polyols, hydrocolloids, natural health, and nutrition products, and other specialty food and feed ingredients.

Archer Daniels Midland has spent the last 14 years working towards diversifying away from low-margin (highly commoditized) businesses like corn processing and into higher margin areas such as specialty foods. That being said, the company's product mix remains sensitive to commodity price fluctuations.
Source: Archer Daniels Midland Investor Presentation

Approximately 45% of the firm's revenue is from the U.S., with most of the rest coming from Europe, the Cayman Islands, and other foreign countries.  

Archer-Daniels has paid uninterrupted dividends 87 years and raised its annual dividend for 43 consecutive years, making it a dividend aristocrat. 

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 rising 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 typically 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 and logistical knowledge, as well as its 1,400 semi-trailers, 28,000 railcars, 2,300 barges, and 10 container ships (another 150 leased) used to transport its products, would be nearly impossible. With razor-thin operating margins in this 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 Daniels' 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 profitability 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 barely generating returns above breakeven. In 2014 the firm sold its South American fertilizer business for $350 million, and in 2018 the company divested its Bolivian oilseeds business and sold several U.S. storage elevators as well.

From a growth perspective, in July 2014 ADM announced an acquisition of natural ingredient company Wild Flavors for $3 billion, the largest deal in its history. Wild Flavors helped the firm 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, the $50 billion specialty ingredients and flavors industry is a space known for its relatively higher customer loyalty and solid profitability. It's also growing at a solid rate of about 5% to 6% per year.

In January 2019, Archer Daniels completed the acquisition of Neovia, a French-based global provider of animal nutrition solutions. That $1.8 billion acquisition, the second largest the firm has ever made, will make Archer Daniels a major player in animal feed, which enjoys higher margins than its less specialized commodity products. The animal feed industry is about $700 billion in size and growing at 3% per year.
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 (about 1.5% of ADM's annual revenue).
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. As of the first quarter of 2019, the firm was on track to hit those cost efficiency targets and achieve $1.2 billion in annual savings (since 2013) by 2020. 

Part of ADM's cost-cutting plan involves selling off or closing older processing facilities, some of which the company has owned for 100 years and thus are more capital intensive due to increased maintenance costs. 

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 represents an important risk.

Key Risks
While Archer Daniels Midland is generally a safer income stock, there are still several concerns for investors to consider.

First, the firm 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), shifting consumer food preferences, 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
The current trade war between the U.S. and China provides another example of an event that could affect Archer Daniels' short-term results. One of the biggest losers thus far has been crop exports, especially soybeans.

China's 2018 soybean imports from America fell by about 50% to their lowest levels in a decade. While a trade deal seems likely to be reached later this year, until a deal is official there is always a risk that ongoing tariffs could negatively impact some of Archer Daniels' biggest customers. 

A longer-term 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 Daniels in an uncomfortable position, having to once again restructure its fundamental business model.

Even if U.S. Ethanol policies don't change in the future, the industry currently has an oversupply problem, which is why in 2017 Archer Daniels converted a 100 million gallon per year ethanol plant for other purposes.

Now it's not all bad news on the regulatory front. In March 2019 the EPA proposed allowing U.S. refiners to blend up to 15% ethanol into gasoline. Should that rule change occur, then it's possible the firm's ethanol business, which makes up a relatively small portion of overall profits, could see a boost, though how much isn't certain since refiners aren't obligated to use ethanol.

A final risk to consider is that Archer Daniels' long-term growth strategy now appears to be more heavily dependent on acquisitions. Every acquisition comes with risks of overpaying and failing to live up to management's expectations.

Archer Daniels' historical competence is in commodity foods and not necessarily the specialty nutrition businesses it's recently been buying. This means management may be stepping outside its circle of competence and risks overpaying for businesses it might not be able to integrate successfully.

A key driver of the firm's long-term earnings growth will be its ability to improve its overall margins and earnings stability by growing its specialty nutrition businesses. These businesses only account for 10% of overall operating profits today, but it's important that management shows the firm can find success in this market.

It's also worth noting that the company has increased its debt load to fund the deals it made in recent years. While ADM's debt levels still look reasonable (ADM maintains an "A" credit rating from S&P), the firm will likely want to reduce its leverage using retained cash flow, and its sluggish earnings growth means only token dividend increases are likely for the next few years.

As you can see, Archer Daniels' adjusted EPS hasn't grown at all over the past seven years. While this business seems unlikely to ever grow by more than a low- to mid-single digit annual rate, investors need to consider the risk that the firm continues to tread water given the continued volatility of its business drivers.
Source: Archer Daniels Midland Investor Presentation

Archer Daniels' 2019 dividend hike of just 3% (quarterly raise of one penny per share) should be expected in years the company is unable to grow earnings. That's because at the end of 2018 the company's payout ratio sat at 40%, which is the upper end of management's targeted adjusted EPS payout ratio of 30% to 40%. The firm's payout ratio range already reflects the more stable cash flow management expects from ADM's ongoing mix shift, too.
Source: Archer Daniels Midland Investor Presentation

Thus prospective investors need to ask themselves if the company's slightly above average dividend yield is worth their patience when dividend growth is likely to be barely ahead of inflation over the next few years. 

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) result in an above-average business risk profile which makes strong and sustained earnings and dividend growth more challenging. 

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, government subsidies, and long-term consumer food trends.

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 Daniels' existing operations.

And at the end of the day, the specialty ingredients industries the company is targeting are merely less sensitive to commodity fluctuations, not entirely immune. Archer Daniels built its empire on commodity goods, then diversified into other commodity products (ethanol), and is now pursuing growth via potentially risky M&A into specialty ingredients.

The company’s dividend appears to remain very safe and offers modest 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 still relatively strong balance sheet.

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