Archer-Daniels Midland (ADM) is a safer, defensive, food-related play to contemplate for investment. Given the inevitability of a sharp increase in money printing by the U.S. Federal Reserve Bank, we could be on the verge of a material spike higher in grain prices and the fortunes of related businesses. ADM is in a similar position to my farm economy picks of Mosaic (MOS) and MGP Ingredients (MGPI), undervalued and underappreciated in March 2020. You can read my expanded bullish arguments for Mosaic here and MGP here.
Under a worst-case pandemic/panic scenario, my thinking is a coronavirus-induced recession into summertime could unleash record money printing by the Federal Reserve and central banks globally. Already on Tuesday, the Fed followed suit with an emergency half of a percent rate cut. With the Treasury bond yield curve well below 2% and short rates approaching 1%, there is almost no room to credibly cut rates further, no matter which direction the economy heads. Truly experimental money printing, including QE purchases of corporate debt and even direct intervention in the stock market (like done in Japan the last decade), cannot be ruled out if the virus disrupts lives and business operations in an exponential, compounding fashion from early March. You can read my article put out last week regarding the expanding odds of a hyperinflationary accident, as paper monies the world over are “devalued” rapidly to prop up financial security prices. While the concept of hyperinflation in America was a lunatic idea 8-10 weeks ago before coronavirus showed up, smart Wall Street players are starting to model what out-of-control money printing could look like in the near future and which investments should be purchased now to hedge such an event.
ADM’s 25% sell-off since December has opened a solid value-based area to buy shares, in my opinion, regardless of macroeconomic swings. It is on the cheap side given stagnant grain prices, but looks incredibly inexpensive if and when grain prices start to rise. Unlike the typical S&P 500 operating business, coronavirus or severe recession will not affect demand for basic foodstuffs and grains to a significant degree. Almost eight billion people on the planet will spend money on food first before buying a new car, or repaying credit card debt. If you want a truly defensive stock to put in your portfolio that serves the dual role as a unique hedge against a spike in food prices for your wealth, this may be the pick for you.
ADM’s grain storage, delivery, processing and refinery assets allow the company to charge a rather consistent percentage rate for its services. Historically, total profits rise and fall with the level of grain pricing, as the company’s overall rate of profit on grain sales remains fairly constant. Of course, each business unit’s fortunes fluctuate with competition and specific management decisions on a day-to-day basis, but if grain prices double in the next 12-18 months, you will likely be a happy camper owning ADM shares.
Image Source: November Investor Presentation
Unfortunately for ADM shareholders the last five years, grains have been stagnant in price and depressed in value versus net farming costs to grow the stuff. U.S. farmers have not made significant profits as an industry since 2014. Below, I have pictured the low and meandering price charts for corn, soybeans and wheat since 2015.
ADM stock price has mirrored the problems in grains finding upside traction. Today’s $38 share quote is approaching a three-and-a-half year low and is slightly under its 5-year average. Below are 2-year and 5-year price charts for ADM. Notice the oversold 14-day Relative Strength Index (RSI) areas circled in green. For ADM and other blue-chips not witnessing major upheaval in their business operations, oversold RSI readings often pinpoint an area to consider long-term purchases.
While grain prices have been punk, ADM has purchased 15% of outstanding shares in the last five years. Effectively reinvesting operating profits and cash flow into shrinking the number of shares and shareholders over time, results “per” share have been zig-zagging higher, albeit slowly. You can review on the graph below, ADM’s current price-to-sales, price-to-book value, and total equity market capitalization are representative of a stronger value proposition going into March 2020.
The net effect of ADM share buybacks is that existing/new shareholders now hold stronger upside leverage to rising grain prices. Without adding interest expense, each ADM share is 15% more valuable than five years ago in terms of ownership of the whole business, all else being equal in our calculations. When grain prices rise again, perhaps very soon from a dollar devaluation caused by coronavirus economic recession, ADM’s projected swing higher in profits will support a rising stock quote. In fact, I am modeling a future price-to-earnings ratio well under 10x, given a 25% climb in grain prices, from the current 11.5x forward ratio using Wall Street analyst estimates of $3.30 for 2020 earnings. What other blue-chip names can deliver a sub-10 P/E during, or just after, a recessionary period in 2020-21? Plus, ADM owners at $38 are getting 3.8% in dividend yield annually, almost double the S&P 500 rate and triple the average Treasury bond yield.
Based on price-to-sales, price-to-earnings, price-to-cash flow and price-to-book value averages in the past decade of trading (cycle adjusted review), ADM is currently selling in the bottom 20-25 percentile range vs. historical valuations. Is it the cheapest U.S. stock to buy based on trailing 12-month results? No. But against the general U.S. stock market overvaluation in early 2020, trading in the 90-95 percentile range using a similar evaluation method, ADM appears to have strong value characteristics for purchasing its steady, dependable business operations. Also, if the U.S. stock market is transitioning from growth to value names, like during the year 2000 after the Tech Boom peak, ADM could soon see plenty of new buying interest.
Archer-Daniels Midland today represents a low-risk way to play a bump higher in grain prices. In addition, ADM may provide a wonderful wealth hedge against the unlikely, but not impossible, appearance of hyperinflationary gains in everyday consumer staples. If the coronavirus pandemic becomes demonstrably worse on the planet, central banks will be forced to print unheard sums of money to offset the economic shock to the global, just-in-time supply chain and consumer spending patterns. As many experts have explained in the national media for weeks, lower interest rates and exaggerated money printing may not help an economy suffering from short-term fear and disruption. What’s getting less attention in the financial press is we could theoretically witness a spike in the price equilibrium for many commodities, directly caused by a loss of faith in what each paper money unit represents.
Buying a defensive food company with a history of strong cash flow and earnings, even during past recessions, could prove a profitable long-term idea for your portfolio’s health and worth. Increasingly turbulent trading activity in the U.S. stock market in the last week could remain throughout 2020, due to a number of factors outside of the coronavirus situation. Archer-Daniels, in fact, may be great medicine for your portfolio and help you sleep better at night. Receiving a well-above-normal 3.8% in dividends annually will also offset the potential for losses in the market or ADM specifically in coming months. The good news is a jump in grain prices should encourage management to increase the dividend payout and continue buying back shares. Statistically speaking, the odds of 10%+ annualized total returns the next 3-5 years from ADM look stronger than those from the majority of S&P 500 companies. Near-record overvaluations in the U.S. stock market just a few weeks ago make ADM an intelligent “relative” valuation buy story.
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Disclosure: I am/we are long MOS, MGPI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author’s opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author’s best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.