ADM is an interesting defensive play - is it a good value?

December 12, 2018

ADM is an interesting defensive play – is it a good value?

Bearish pressures for the past few days have pushed the market back down near to its 52-week lows. It seems like each time the market tests its major support, more and more talk starts to be about the increasing likelihood that the longest bull market in recorded history is finally going to end. So far this year, each time that’s happened the market has managed to stage yet another rally; but given the extremely extended state the market remains in, even being in corrective territory right now does seem to suggest that support will probably only hold for long.

Increasing uncertainty in the stock market is usually something that prompts investors to seek safe havens for their money. That often means fixed-income assets like investment grade bonds, including Treasuries; but it can also mean focusing on stocks whose business profiles tend to be less sensitive to economic cycles. One of the areas I tend to focus on the most is Consumer Staples, and food stocks in general. In fact, while the market has dropped back into correction territory since October 1, this sector saw a positive, if modest bump of a little over 3% as measured by the S&P 500 Consumer Staples Sector SPDR ETF (XLP). It is also up since the beginning of May by a little over 13%, which puts it ahead of most other sectors over the same time period.

Archer Daniels Midland (ADM) is a stock that most people should be familiar with; it is one of the largest agribusiness companies in the world, with a major market present in agricultural processing and merchandising. Another reason I like to think of stocks like ADM as defensive in nature is the fact that when the market turns bearish, and investors are putting quality at a premium, large-cap stocks in defensive industries tend to get the most attention. The fundamentals for these companies tend to be the strongest, and usually offer dividend yields that help them compete favorably with bonds and other interest-bearing instruments. ADM’s fundamental profile has a couple of holes that should prompt a cautious view of the stock, and I’m not sure that it has a compelling value story to tell yet; all the same, this is a stock that is worth paying attention to as we wait for the market to play out the next phase of its trend.



Fundamental and Value Profile

Archer-Daniels-Midland Company is a processor of oilseeds, corn, wheat, cocoa and other agricultural commodities. The Company manufactures protein meal, vegetable oil, corn sweeteners, flour, biodiesel, ethanol, and other food and feed ingredients. Its segments include Agricultural Services, which utilizes its United States grain elevator, global transportation network and port operations to buy, store, clean and transport agricultural commodities, such as oilseeds, 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; Corn Processing, which is engaged in corn wet milling and dry milling activities; Oilseeds Processing, which includes global activities related to the origination, merchandising, crushing and further processing of oilseeds; Wild Flavors and Specialty Ingredients products, which include flavors, sweeteners and health ingredients; Other, and Corporate. ADM’s current market cap is $25 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased more than 100%, while sales increased a little over 6.5%. The last quarter is markedly less optimistic, since earnings decreased almost 10%, while sales dropped about 7.5%. The company operates with a very narrow, but stable margin profile; Net Income versus Revenues over both the past year and the most recent quarter is about 3.5%. That narrow margin isn’t unusual for food companies, but the relative stability of ADM’s profile is something that gives the business a bankable model to work with.

  • Free Cash Flow: ADM’s free cash flow is negative, by about -$4.7 billion, and that is a red flag; it is an indication that the company’s financial flexibility is becoming more restrictive.
  • Debt to Equity: ADM has a debt/equity ratio of .35. This is a conservative number, but in this case doesn’t improve the fundamental profile. The company’s balance sheet indicates that operating profits are adequate to service their debt, but with more than $6.7 billion in long-term debt, and negative Free Cash Flow, liquidity is a question mark.
  • Dividend: ADM pays an annual dividend of $1.34 per share, which translates to an attractive yield of 3%.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for ADM is only $33.94, and which translates to a Price/Book ratio of 1.31 at the stock’s current price. Their historical average Price/Book ratio is 1.42, which puts a long-term target price at about $48.19 per share. The stock’s Price/Cash Flow ratio is more interesting, since that is currently trading about 16% below its historical average and provides a target at around $52 per share.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The stock’s downward trend since October runs counter to the trend of the broader sector over the same time period, and is one of the reasons that I think the stock is becoming more interesting. It is currently consolidating at around $44 per share, with strong support if that price region from previous pivot points in March and May. A drop below that support could see the stock test its 52-week low prices around $40 per share.
  • Near-term Keys: It’s hard to see where any kind of bullish short-term trade would be a good idea right now, given the strength and momentum of the stock’s current trend. The stock would need to break above trend resistance at $47 to provide any kind of useful bullish signal to buy the stock for a swing or momentum trade or to buy call options. If the stock breaks current support, you might consider shorting the stock or buying put options with an eye on $40 as a near-term price target. The stock’s value proposition doesn’t start to get really compelling until the stock gets down at least to that level, and given the short-term trend’s momentum I think the stock is more likely to test that low than it is to stage any kind of bullish rally in the near term.