Archer-Daniels-Midland: An Opportunity Has Opened Up for Patient Investors
Here's why the cloud over the company may not be as dire as the stares reflect right now.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
Wall Street can't be blamed for shooting first and asking questions later in regard to accounting irregularities.
Recently, Archer-Daniels-Midland ADM , one of the largest global agricultural processing companies, was in the crosshairs after announcing accounting problems at their Nutrition unit, slashing earnings estimates for Q4, and placing the CFO on administrative leave. Analysts were as stunned as the rest of the Street and helped pressure the shares by piling on with four downgrades and taking a hatchet to price targets. Unrelenting selling ensued, hitting ADM to a multi-year low, a punishing 25% loss on the news.
Justifying downgrades, analysts cited, in part, the cockroach theory that if ADM placed the CFO on leave, more accounting irregularities could be uncovered. Plus, analysts noted that most of ADM's business segments are under margin pressure and currently underperforming, so prudent investors ought to take to the sidelines.
Here is what is known of the bad news: ADM's Nutrition unit, which accounts for 8% of revenues, has an ongoing investigation for certain accounting practices and procedures, including inter-segment transactions. Aside from the accounting mess at Nutrition, ADM lowered its 2023 profit outlook to $6.90 per share while the Wall Street consensus was $7.29. This implies an especially weak Q4 of $1.28 when the Street was closer to $1.67. The headline risk is also real, with news breaking this past Monday of a DOJ probe into the Nutrition unit's accounting.
While the pain to shareholders has been acute, an opportunity has opened for patient investors to buy shares at an attractive price. Much negative news is now baked in and the shares are on sale. Although the stock is unlikely to have a short-term sharp snap-back, buying should prove an attractive longer-term entry in the agricultural giant's shares.
ADM, with a forward P/E of 8 and dividend yield of 3.7%, trades at a low multiple expected for a player in the commodity industry. It's a complex company with many moving parts with profit margins challenging to predict year to year due to commodity volatility. Yet, the company bought back 20% of shares outstanding over the last decade and the stock currently trades at a historically low P/E level for ADM, only matched during the great financial crisis.
No doubt the ADM story has a lot of hair on it right now. The question is if the shares are overly discounting bad news due to the palpable uncertainty about how extensive the problems reach. In most outcomes, the risk/reward could be considered favorable.
ADM's valuation reflects its current difficulties, with EV/EBITDA at 6.3 vs the five-year average of 9x. This implies a potential 40-50% return if shares normalize to their average multiple.
Considering the unit in question accounts for only 8% of revenue and there's weakness in ADM's main agricultural services business, the cloud over the company may not be as dire as the stares reflect. The storm will take time to pass, but the risk/reward sets up favorably for those willing to be patient buyers of shares at a multi-year low.
ADM is an essential agricultural industry player with a solid history of profitability. Aside from accounting irregularities, the shares are discounting cyclical weakness in its core business, especially in soybean crush margins, which is usually a favorable time to buy commodity-related stocks.
At the time of publication, Ginesin was long ADM, short ADM calls
