Are you wanting to diversify your portfolio away from banks, techs, industrials? Maybe you should consider an investment in agriculture, which can hedge food inflation down the road. The good news is you don’t have to plow and harvest the crop yourself to benefit! You can earn a decent dividend and partake in grain commodity advances, sitting in your downtown high-rise living room. How? Just purchase shares of Archer-Daniels-Midland (NYSE:ADM).
ADM was founded in 1902 and is headquartered in Chicago, Illinois. It is the largest U.S. shipping, storing and processing enterprise in the grain business. Everything from oils, flavors, meals, feed, alcohol, and ethanol is part of the processing equation. When people and livestock eat, they are likely biting into foods ADM can claim it had a hand in bringing to the table or feeder. The company is ranked as the #2 U.S. ethanol maker by volume. Corn is converted into an oil and blended with gasoline to make cleaner, more sustainable fuel for vehicles.
Image Source: ADM Presentation
I mentioned the company as a smart food processing name to hedge the potential of climbing grain prices in March here. Without doubt, the record money printing by the Federal Reserve in response to the coronavirus pandemic and related economic shutdowns is leading to grain price changes. The basic M-1 money stock (cash in circulation and checking account balances) has risen +41% the last 12 months, by far the greatest pace of expansion in modern history.
And, the odds of new federal deficit spending in 2021 look good with the election gains made by Democrats. 2020’s extra $5 trillion in Treasury debt will likely grow another $2-3 trillion next year to stabilize the economy. Lots of cash in the financial system should convince consumers spending your money is a better idea than saving it. The end result of all the money laundering and exchanges and printing and borrowing will be higher prices for commodities.
During the 1970s spike in commodities, after America left the gold standard for dollars, ADM was a top Wall Street performer. It leveraged regularly rising grain prices into a high-growth acquisition strategy. Today, food inflation is already happening. Overall food price gains are running about +4% year over year currently, leading industrial commodities like energy.
Image Source: U.S. Inflation Calculator
Grain Prices Rising
Soybeans, in particular, have led grains to the upside in 2020. I talked about the bullish supply/demand setup for the Teucrium Soybean ETF (SOYB) back in June. Since the March bottom, soybeans have risen nearly +40% (+30% from my article mention). Below, I am charting the nearest futures price for the major grains of wheat, corn and soybeans over the last 12 months of trading. I still rate soybeans as having the strongest chart pattern and foundational momentum, with corn catching up quickly.
Improving ADM Income Estimates
You can see the impact of rising grain prices during the second half of the year on Wall Street’s earnings estimate revisions. ADM’s income is largely a function of delivering 2-3% in after-tax profit margin on sales. So, when sales rise from either higher volumes or growth in the pricing of underlying commodities, shareholders benefit. After the coronavirus pandemic fades next year, I suspect all the money printing will combine with a stabilized economy to spur higher global ADM sales, income and cash flow. Volumes and pricing may both improve into 2021-22. Below are charts of the steady increase in EPS expectations the next three years, alongside a 10-year review of net profit margin.
Decent Long-Term Valuation
While valuations are drifting toward decade highs against underlying fundamentals for the operating business, a 35-year comparison highlights price to trailing annual sales and book value are on the low end of the spectrum. Remember, the average S&P 500 business is today selling for record high price to sales and book value multiples. So, ADM’s valuation, in a relative sense, is a unique bargain vs. alternatives in the U.S. equity marketplace.
You would think ADM’s undervaluation against long-term historical comparisons would be accompanied by high debt levels and weak operating numbers. But this is not the case. Debt measured against total assets is actually quite low, pictured on the graph below since 1989.
ADM’s debt level is conservatively positioned, in a capital spending-intensive industry. Compared to other major food processors Bunge (BG), Conagra (CAG), General Mills (GIS) and Kraft Heinz (KHC), debt to asset levels are low, and interest coverage by earnings is strong. 5-year graphs are drawn below.
ADM’s dividend yield is also in its best relative position vs. the S&P 500 average equity and the U.S. bond market in recent memory. Over the last decade, the company’s cash distribution yield has hovered slightly above alternative investments. However, the current 2.9% rate is now double the equivalent yield of the SPDR S&P 500 ETF (SPY) and 20+ Year Treasury Bond ETF (TLT). Then, consider ADM’s dividend payout tracks rising food inflation in close correlation. If grain prices double the next 2-3 years, future dividends may rise strongly for ADM investors, perhaps at a 20%+ clip.
Technical Momentum Setup
The stock has been under heavy accumulation since June, as measured by the Negative Volume Index [NVI] and On Balance Volume [OBV] indicator. NVI specifically has caught my attention since early October. Marked with a red arrow on the 12-month chart below, NVI follows buying/selling on low volume days. If a stock quote rises strongly on light volume, one has to question the overhead supply situation. The rising OBV line signals more dollars are being spent to push up prices on advancing days than are taken out of the equity on down days. The Accumulation/Distribution Line has likewise been trending higher in a healthy fashion all year.
ADM represents a wonderful food inflation hedge at today’s quote. Excessive money printing has put a floor under grain prices in U.S. dollars. An above-average dividend yield, with above-normal odds of strong payout growth is worth more research for your portfolio. Why not earn some green off the farm economy, laying on your recliner at home?
I have not owned ADM shares in months, but am hoping for some price weakness to initiate a new stake. Quotes in the $45-46 area would open an even smarter buy opportunity, especially in the context of a hedged and diversified portfolio design. Holding Archer-Daniels-Midland long against a list of weakly performing short sale candidates may be the most opportunistic design. Using this portfolio construction, ADM will be considered a winning trade, as long as it “outperforms” your short picks and the overall equity market. Accepting limited gains from this setup is worth the reduced risk during a sharp market sell-off phase.
You can even short the indexed SPY ETF as an offset, in this long/short design. For example, if the S&P 500 average company declines 30% during 2021, but ADM falls only 20%, an investor keeps a net +10% price gain (before trading expenses and short sale borrowing costs). The rough 3% dividend yield received from ADM also matches well with a borrowed SPY dividend cost of 1.6%, over the course of a year. Likewise, if ADM jumps 40% next year, while SPY rises 20%, an investor nets +20%!
Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.
Want to read more? Click the “Follow” button at the top of this article to receive future author posts.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ADM over the next 72 hours. 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: I am short SPY.
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.