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. Lately, the cycle of uncertainty seems to have swung back to the side of optimism, as hope persists that the U.S. and China will reach the first stage of a long-term trade agreement soon and head off the imposition of even more tariffs next month. The latest round of earnings, which is now winding down, also gave investors investors reason to be hopeful as corporate profits have generally come in stronger than expected.
Increased volatility usually results in wide swings from high to low and back again; that 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.
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 or so is Archer Daniels Midland Co. (ADM). From a peak in October of 2018 to a low price around $38 in early August, the stock declined a little over -27%, but has rallied back from that point to its current price around $43. That’s a gain of almost 20% over that time period, with a little more than 8% coming in just the last month.
ADM’s stock price has struggled, reflecting the company’s sensitivity to geopolitical issues and trade. The ongong trade war with China, for example has hit the company hard, since reports indicated China held off on buying U.S. agricultural commodities as a way to retaliate against Trump-imposed tariffs on virtually all Chinese goods. That has been 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 which has 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 protein production back up again. These are factors that seem likely to help the stock’s fundamental profile, which has signs of both strength and weakness, start to improve even more. Is the stock’s latest rally a reason for a value investor to consider a new long-term position? Let’s look.
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 about $23.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased more than -16%, while sales rose almost 6%. In the last quarter, earnings improved significantly, increasing almost 28.5% while sales rose modestly, at just 2.63%. 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 1.85%, but improved somewhat in the last quarter to 2.43%. That narrow margin isn’t unusual for food companies; the question is whether the increase in the last quarter is a sign of fundamental improvement or just single-quarter anomaly.
Free Cash Flow: ADM’s free cash flow is negative, by about -$5.6 billion, and that is a big 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 -$5.1 billion, and -$4.7 billion in the quarter prior to that.
Debt to Equity: ADM has a debt/equity ratio of .40. 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 $5.35 billion in cash and liquid assets versus more than $7.6 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 likely 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 3.27%.
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 $33.94, and which translates to a Price/Book ratio of 1.26 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, or just about 8.14% above the stock’s current price. The stock’s Price/Cash Flow ratio is more interesting, since that is currently trading about 34% below its historical average and provides a target a little above $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 of last year 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 has staged an interesting intermediate-term upward trend, with the latest peak in that trend coming just a few days above a little below $44 per share. A break above that point could see the stock rally in the short-term to about $46 where the 61.8% Fibonacci retracement line rests. Current support is around $42.50 at the 38.2% Fibonacci retracement line. A drop below that line would mark a reversal of that upward trend, and could see the stock drop back to about $40 based on prior pivot activity in that range.
Near-term Keys: The stock’s current upward trend could provide an interesting catalyst for a short-term, bullish continuation of its current trend; a break above $44 could act as a signal to buy the stock or work with call options with an attractive short-term target at about $46 per share. If the stock drops below support at around $42.50, you could consider shorting the stock or working with put options with an exit target for a bearish trade at around $40. The stock’s value proposition, unfortunately, isn’t supported by the stock’s fundamentals; it would be important to see ADM’s current pattern of declining Free Cash Flow reverse and start to show signs of improvement before I would be willing to take the stock more seriously as a long-term investment opportunity, despite some intriguing macroeconomic reasons to think ADM’s prospects could be poised to improve. The smart approach for now as a value investor is to be patient and wait to see if those factors can be seen over the next quarter or two.