Thursday, January 28, 2010

ADM – Priced for Dividend Growth Portfolio

Archer Daniels Midland (ADM) is one of the world's leading agribusiness companies, with significant market presence in agriculture processing and merchandising. ADM has approximately 230 plants located worldwide. It is one of the world's largest processors of agricultural commodity products such as oilseeds, corn, wheat, protein meal, corn sweeteners, flour, biodiesel, ethanol, and other food and feed ingredients.

ADM is a dividend aristocrat and has been raising its dividends for last 34 years. The last dividend increase was in February 2009. I last reviewed ADM in July 2009. My objective here is to see if ADM continues to be a good dividend growth stock and how does it rate on my scale of risk-to-dividends.

Trend Analysis

Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts is shown in image below.

  • Revenue: In general, a growing trend since 2000. The average revenue growth for last 9 years is 21.3%.
  • Cash Flows: Very erratic operating cash flow with significant reductions since 2005. Negative in 2007 and 2008. Same trends for free cash flow. Not a good observation.
  • EPS from continuing operation: In general, increasing trend, between 2000 and 2007. Slow reduction since 2007.
  • Dividends per share: Consistently growing dividends since 2000 (and before that since last 34 years).

Risk Parameter Calculation

Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 2.09. This is a medium risk category as per my 3-point risk scale. The negative EPS growth rate in 2008/2009 makes it a medium risk to dividends.

Quality of Dividends

This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

  • Dividend growth rate: The average dividend growth of 17% (stdev. 8.7%) is less than average EPS growth rate of 28.6% (stdev. 39.1%). Dividends have grown slower than earnings per share.
  • Duration of dividend growth: 34 years.
  • 4 year rolling dividend growth rate for past ten years: More than 10% for past 8 years. 14% for last five years.
  • Payout factor: In the past 8 years, it has always been less than 35%. Presently, it is at 21%.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.1%; and (b) MMA yield is 1.75%. Last 8 years average dividend growth rate has been 17%, however, my expected dividend growth rate is 8.5%. With my projected dividend growth of 8.5%, the dividend cash flow is 1.76 times MMA income in 10 years time period.

Fair Value Calculation

  • This section determines what price I should pay to buy a given stock
  • Net present value (NPV) price based on 15 year DCF: $28.6
  • Average high yield price calculated based on past 10 years: $20.5
  • Pricing based on past 10 year relative price-to-earnings ratio. $45.7
  • Pricing based on price-to-earnings ratio of 12: $35.0
  • Graham number: $31.4

The range of fair value is calculated as $24.1 to $30.3.

Qualitative Analysis

ADMs history can be traced back to 1902. It has survived all the significant ups and downs in the economic growth of United States. This demonstrates that it keeps adapting to changes in the market place.

  • ADM is continues to maintain its leadership position in agriculture business, with its unparalleled global asset base, flexible processing capabilities, and financial strength. Unlike its business competitors, ADM focus on long term profitability and sustainability.
  • It is operates in a cyclical commodity industry. While current recession seems to have had an impact on its year-over-year financial results, it continues its asset expansion through acquisitions and capacity expansion. To me any corporations that still can go down that path in recession is something that shows positivity and management’s confidence.
  • It’s year-over-year may show cash flow concern or reduced EPS. However, I believe those are due to capacity expansions and acquisitions.
  • In addition, a lot has been said about ADM’s push into ethanol business and its long term viability and sustainability. I believe ADM has positioned itself (and still continues to do so) as an undisputed leader of ethanol producer. The market for alternative fuel is bound to grow in future.
  • One thing that came as a surprise to me was the gross margins and operating margins are in single digits. Perhaps, it is the operational capability that allows it to maintain continued profitability at such low margins. However, at such low margins, there is no room for error.
I like ADM’s global asset base, focus on long term profitability, and diversified product strategy. I also like ADM as a proxy for agriculture commodity asset class. It has been raising dividends for last 34 years. The stock’s current risk-to-dividend rating is 2.09 (medium risk). I am long on ADM, and would continue to add based on my allocation levels. However, before I add any new positions, I will wait for declaration for 2010 dividend increase which I expect sometime in February 2010.

Full Disclosure: I am long on ADM.

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