When investors start to get more nervous about the sustainability of economic growth, and therefore of the market in general, volatility tends to increase. That means that stock prices tend to see wider-than-normal swings from extreme high to extreme low. Most of the market’s current uncertainty seems to be focused on the prospect that economic growth in the U.S. may slow in the months ahead, rather than on any actual indications that it has started to happen.
Increased volatility can make investing a bit scarier for some investors, and that’s why it isn’t uncommon under these kinds of conditions to see what analysts often call a “flight to quality” – which can mean a few different things. It often translates to an increase in buying activity for interest-bearing instruments like bonds. Bond yields lately have been dropping, however, including a much feared “inverted yield curve” – where the two-year yield on Treasury notes has moved above the yield on a 10-year Treasury bond. That’s actually been another source of tension for investors, since most analysts consider a yield curve inversion a leading indicator of economic recession.
Besides the bond market, “flight to quality” can also mean buying stocks in industries that are generally expected to show relative stability, even the economy is struggling. One of the industries that I like to focus on when I see uncertainty increasing is Food. While not all stocks in the industry pay a dividend, many of the strongest names do, with yields that usually compare pretty favorably with short-term bonds. One of the stocks in this industry that really struggled over the past year is Archer Daniels Midland Co. (ADM). From a peak in October of 2018 to a current price around $38, the stock has declined a little over -27% in the past year.
ADM’s stock price has struggled, reflecting the company’s sensitive to geopolitical issues and trade. The current trade war with China, for example has hit the company hard, since recent reports indicates China is not buying U.S. agricultural commodities as a way to retaliate against Trump-imposed tariffs on virtually all Chinese goods. That is a big headwind for a company like ADM, which relies heavily on soybean and ethanol exports. It is also true, however, that China is currently experiencing a protein crisis, driven in no small part by the outbreak of African Swine Fever began a year ago in China, and have extended lately into Russia. That has created a major hole in global pork inventories that analysts expect ADM will benefit from, as they will be able to supply higher levels of corn and soybeans to affected markets that are just starting to ramp product back up again. These are factors that seem likely to help the stock’s fundamental profile, which has signs of strength and weakness, start to improve even more. Given the stock’s decline over the past year, it also seems to suggest the time could be right to take its value proposition seriously.
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 $21.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased more than -41%, while sales dropped about -4.5%. In the last quarter, earnings improved significantly, increasing almost 30.5% while sales rose about 6.5%. The company operates with a very narrow margin profile that has shrunk in recent quarters, which is reflective of many of the broader pressures I already referred. Net Income versus Revenues over the past year is 2.08%, and declined in the last quarter to 1.44%. That narrow margin isn’t unusual for food companies, but the deterioration its pattern into the last quarter is a concern.
Free Cash Flow: ADM’s free cash flow is negative, by about -$5.1 billion, and that is a red flag; it is an indication that the company’s financial flexibility is becoming more restrictive. This is a number that, like Net Income, has also gotten worse; in the quarter prior, Free Cash Flow was about -4.7 billion.
Debt to Equity: ADM has a debt/equity ratio of .41. 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, with about $5.2 billion in cash and liquid assets versus more than $7.7 billion in long-term debt; however ADM’s negative Free Cash Flow suggests that the company is having to rely largely on cash to service its debt. The long that condition persists, the more like liquidity is to become a question mark.
Dividend: ADM pays an annual dividend of $1.40 per share, which translates to an attractive yield of 3.69%.
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 $34.08, and which translates to a Price/Book ratio of 1.11 at the stock’s current price. Their historical average Price/Book ratio is 1.36, which puts a long-term target price at about $46.35 per share. The stock’s Price/Cash Flow ratio is more interesting, since that is currently trading about 52% below its historical average and provides a target at around $57 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 has become more interesting. At the beginning of August the stock set a new 52-week low around $36.50, and since that point it has began to hover in a narrow consolidation range with resistance around $38.50. A break above that level could give the stock some good short-term momentum near to $42, where the 38.2% Fibonacci retracement line sits. If it breaks below its current support, its next likely support level is probably around $34, with the stock’s multiyear low around $31 (reached at the beginning of 2016) not too far from that point.
Near-term Keys: The stock’s current consolidation activity could provide an interesting catalyst for a short-term, bullish recovery in the stock; if you’re willing to be aggressive, a break above $38.50 could act as a signal to buy the stock or work with call options with an attractive short-term target at about $42 per share. If the stock drops below support at around $36.50, you could consider shorting the stock or working with put options with an exit target for a bearish trade at around $34, or possibly even around $31 if bearish momentum really starts to pick up. The stock’s value proposition is interesting at this level, and it is true that there are some intriguing macroeconomic reasons to think ADM’s prospects could be poised to improve. My preference would be to see improvement in the company’s Net Income, and a reversal of its negative, declining Free Cash Flow pattern before taking a long-term opportunity with this stock seriously.