ADM – A dividend stock to own for the long term

Contents

ADM company overview

Investment strategy

A few notes from the last conference call

My personal opinion

I analysed Bunge, as it seems like the cheaper stock between the two, but ADM looks like a better business.

ADM company overview

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Source: ADM investor presentation

Unlike Bunge, they grow by acquiring smaller players and including them into their business model and possibly scaling the smaller acquisition.

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Source: ADM investor presentation

Operating profits are stable.

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Source: ADM investor presentation

And earnings per share too.

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Source: ADM investor presentation

The return on capital is 300 basis points (3%) higher than Bunge’s and 200 basis points above their cost of capital.

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Source: ADM investor presentation

They plan to increase the dividend pay-out ratio by 30% in the medium-term range.

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Source: ADM investor presentation

The increased dividend payout should lead to constantly higher dividend yields. Thus, what is now 3.24%, could quickly become 5%. 

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Source: ADM investor presentation

The last dividend is their 349th consecutive quarterly payment and an uninterrupted record of 87 years.

Net debt is smaller than Bunge’s and the available liquidity allows for flexibility. 

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Source: ADM investor presentation

Investment strategy

If ADM continues to grow as it did in the past given that it has the foundations to do so, plus the acquisition potential, I would assume its operating profits could reach $5 billion per year over the next 10 years.

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Source: ADM investor presentation

This also means that distributions to shareholders would be 50% higher than in the last 10 years where the dividends paid out were $5.5 billion and buybacks $6.1 billion. Thus, over the next 10 years, allowing for the normal cyclicality in the food sector, I would say ADM could return at least $15 billion to shareholders. That implies a 6.5% dividend and buyback yield. 

Also, if profits increase 50%, we could estimate the stock price to increase accordingly. So, in 10 years the stock price will probably reach $60 at some point. This adds another 4.1% yearly yield and makes ADM a probably double digit investment over the long term. 

If food prices increase significantly, processing margins improve, there could be exuberant periods like it was the case in 2007, 2014 and 2018.

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The total shareholders equity is $18 billion on a $23 billion market cap giving some margin of safety, but the accumulated depreciation is $15 billion. We could assume that some things can still be used even if the accounting value is zero. The replacing value could be much higher than the $10 billion carried on the balance sheet. 

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Source: ADM Morningstar

There is also the 24.9% stake in Wilmar, a $15 billion company traded in Singapore. The value there is $3.75 billion. 

A few notes from the last conference call

The plan is to save $1 billion from efficiency improvements and digitalization. I remember when I worked for Dow Chemical, there were all these little projects and I can tell you those improved small efficiencies cumulate over time. I see Dow did manage to improve margins over the last decade, the plan is that ADM could save $1 billion.

They expect higher interest payments as they are investing now for the long term, something Bunge can’t do as it has to deal with its issues which makes it another advantage for ADM.

In 2019 they will complete the acquisition of a French animal feed business, Neovia for $1.8 billion in cash. Neovia’s target was to reach $230 million of EBITDA by 2025, perhaps they will reach it sooner now.

ADM is a growth story with more than $7 billion in growth investments over the last five years including key investment like WILD for Taste ($3 billion), Biopolis for Health & Wellness, Neovia for Animal Nutrition, Algar in South America and Chamtor in Western Europe as well as other bolt-on additions and organic investments

My personal opinion

I target an investing business return of 15%. ADM’s average earnings and cash flows point to a 10% investing return so I have to be patient and put this on the watch list. You never know what can happen, but around $30, this might be a very interesting investment. For now, it looks like a good one. 

Also, as ADM’s CEO said, low interest rates allow for high investments that leads to high competition and food oversupply, consequently leading to low margins for processors. ADM is doing fine in this environment, if the environment changes over the next 10 years, ADM might do even better so something to keep in mind. We have been having 5 years now of bumper crops thanks to good weather globally. 

On $3.4 billion in operating profits, $1 billion in capex and about $350 million in interest expense I get to cash flows of around $2 billion. On a $23 billion market cap, that is a 9% return. Given the possible future growth of 4% per year as demand for food grows, I would look at this and compare to my other holdings at 12%. So, ADM’s market cap should be around $16.5 billion for me. That is another 30% down to $30 for the stock price. It is highly unlikely that it ever gets that low, but you never know. Let’s put this on the watch list. If you are happy with the exposure to food, like 10% per year, ADM looks like a stable and shareholder rewarding option. 

Less aggressive investors could wait for opportunities below $40 but anything below $45 seems like a good buy for 98% of investors. 

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Source: ADM investor presentation

Earnings per share are $3.19, we can assume growth of 4% over the long term and a terminal value at a PE ratio of 12.

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If the stock price drops to $30, we would have a 7% return from the stock which would bring this to 11%. 

So, cash flow return is 9%, stock plus dividend return around 7%. Thus, in line almost.

I am analysing the food sector and I must say, ADM looks better than Bunge, also better than Ingredion as it offers more stability thanks to scale. 

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Food Stocks Sector Analysis And Investment Strategy

Do food stocks offer a margin of safety?

Before discussing food stocks as investing opportunities, let me just tell you why I am researching the sector at the moment (March 2019).

I like to invest in sectors that offer businesses with a margin of safety. This means that:

  • there is a tailwind because of what is going on in the world (more people);
  • businesses are already profitable and established (dividends and positive earnings);
  • what will happen is relatively predictable (you are going to eat tomorrow);
  • there are moats with high barriers to entry (logistics, scale, legacy etc.).

On the other hand, you have also very interesting sectors like Software as a service that are bound to grow, but I have no idea which provider will be a winner and whether it has a moat strong enough to insure long term profitability. If we look at the price to sales ratios of such tech stocks, we can see that there is a long way to go before those become profitable.

1 software as a service

Source: Justin Swierczek

The main difference between the two investing approaches is the approach to risk. With a margin of safety, you try to limit your downside but you also limit your upside on a specific stock. However, you are not necessarily limiting your total portfolio return. Buying stocks with price to sales above 10, implies a big potential for a total loss while buying food stocks limits the downside in many cases. Therefore, I am researching the food sector with the hope that I find something interesting to follow and maybe buy.

Food stocks – sector overview

I always like to go through long lists when researching a sector. Looking at each individual company gives me a good comprehension of what is going on in the sector.

2 list

Just from a quick look at some food stocks traded on the NYSE shown in the above list, I have concluded the following:

  • There is a lot consolidation where 6 out of 30 businesses in the above list have been taken over in the last few years. Consolidation means two things, a young market or an aging market. In this case, it is the latter where companies like Campbell Soup, Kraft Heinz, Tootsie Roll are finding it difficult grow. This forces them into expensive acquisitions that are usually a poor allocation of capital.
  • The second thing I found is that brand strength is declining and people look for new, different things. This leads to declining sales and many value traps. One example that I discussed before the actual stock decline, is Kraft Heinz.
  • It is not easy to find a business that is really getting traction within the new trends, as those change quickly.

Investing in the food sector

So, what are the tailwinds in the food sector?

  • The decreasing availability of land;
  • An anticipated increase in commodity prices over the long term due to finite resources and a growing, increasingly wealthy, global population;
  • The shift towards meat based diets, increasing the need for grain based feeds;
  • The creation of markets in farm-related carbon credits and water rights;
  • The increasing levels of investment by land-poor and food-deficient countries, attempting to protect food supplies;
  • The increasing value of farmland.

I don’t know why, but I am not fully convinced about the above tailwinds. I look at food prices, and see them mostly go down.

3 food prices

Source: FAO

The keys here are technology and investments. Each country subsidizes food production, which leads to heavy investments and overproduction. Further, improvements in technology, GMO etc. leads to more production that leads to lower prices, especially if there is nice global weather as we have had the last few years.

So, again value investing comes in handy here. You have to look for an investment where, you win big if food prices increase, but you still win if food prices stay low for the next 10 years.

Also, something tricky when it comes to food prices is ethanol and biodiesel. Politicians can simply say we will have to use other forms of energy, or oil prices can stay low, and a big part of demand for food would vanish.

On the other hand, there are many different trends in the food industry that we cannot put them all under one hat and call them food. There are organics, ingredients, flavours, spices, processed foods, private labels etc.

Bunge Stock Analysis

BG is a food trader and processor, grains, soy, corn with some other adjacent businesses.

Many are waiting for a stock market crash to buy things on the cheap. Well, you have one here.

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Source: BG Stock Price 5-year chart

The business is 200 years old and has been constantly rewarding investors. Over the last 10 years, 50% of the current market capitalization has been returned to investors.

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Source: Bunge IR

They business model is focused on increased volumes in food trade and processing.

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Source: Bunge IR

We have seen volatile food prices  in the past, consequently BG’s cash flows have also been volatile.

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Source: BG’s cash flow statement – Morningstar

On top of everything, there have been rumors that Glencore or Archer Daniels will acquire BG. As these things take time, perhaps it will push the stock price up in the short term but I still have to research it in depth and compare to other opportunities like the already mentioned ADM, Wilmar and some others food businesses traded around the world.

Conclusion

To conclude on investing is food, it all boils down, like in most cases, to the specific business, the quality of the management, the moat, the cash flows, the growth, risk and of course, the price you pay. So, there is no point in discussing what will happen, will we eat more of this or that, the focus has to be on the businesses and I am going to analyse a few businesses for you, to give you an indication of what can be found and what are the dangers.

BG is a completely different investment now at $50, then it was at $90. So, let’s continue looking at businesses and focus less on things we cannot know and forecast.

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Porsche SE is Undervalued – Volkswagen Stock Analysis

In the last few weeks I have received probably more than 5 tips from various sources to look into Porsche SE, because it is extremely undervalued and there is a lot of potential for the stock over the next few years. I’ve read a few hundred pages of reports and this article summarizes my conclusion.

Content:

Porsche SE ownership of Volkswagen and holding discount

Volkswagen stock analysis

Undervaluation – relative and absolute

Personal opinion and conclusion

What is the deal?

Porsche SE

Porsche SE (PAH3) is a company holding Porsche’s family stake into Volkswagen (VOW3). In 2007, Porsche tried to take over VOW, the didn’t make it and VOW took them over. As part of the deal the Porsche family got shares in VOW. The following is the holding structure:

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Source: Porsche

It is important to note that the Porsche-Piëch family has all of the voting shares so you can only buy preference shares. (Also traded as ADRs on NYSE)

VOW3 – 501 million shares – 19 February 2019 price is €141.6 for a market cap. of €71 billion.

PAH3 – 306 million shares – 19 February 2019 price is €54.62 for a market cap of €16.7 billion.

PAH3 owns 30.8% of the subscribed capital of VOW3, thus €21.8 billion.

The discount is sometimes bigger and sometimes smaller as the stocks don’t trade in sync.

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Source: Bloomberg

In any case, buying PAH gives you a 24% discount on VOW at the moment. The key is to look at whether VOW is worth buying in the long term and one can always debate about the holding discounts.

VOW stock analysis

VOW, like any other car company is a cyclical and you have to put it into that bin or folder. Cyclicals do very well when the economy is doing good and terribly when the economy is slowing down as companies buy less cars etc. However, you can only postpone a purchase for a year or two, sometimes a bit longer, but then buyers usually rush back to replacing their old cars with new ones.

Can we predict the cycle? Impossible to do accurately, especially with all the central bank interventions. So, what I prefer doing is simply estimate a recession every 5 years, see how an average one would hit the company, see how the company is doing when things are fine, like those have been in 2018, and get to average earnings that we can use to calculate intrinsic value.

In my book, Modern Value Investing, I analysed Daimler as an example, when writing the stock price was €70, my fair value was closer to €40 and fortunately for my book sales, the stock is closing in on the second price.

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Source: Bloomberg

As there are fears of a recession, the stock falls, when the sentiment is more upbeat, the stock is up. Therefore, one has to buy these stocks when there is blood on the streets. However, before buying, one must know what would be a good business price to pay for a decent long-term business/earnings return. Let’s see.

VOW group hopes to increase their return on sales by 1.5 percentage points by 2025. Given sales are €230 billion, it would not be a bad thing.

4 return on sales

Source: VOW

But, just to stay conservative, let’s say they don’t improve there. On the cash flow, they have their benchmark at €10 billion, a level they can achieve and have been achieving.

5 cash flow

Source: VOW

So, in a bad year, cash flows will probably be €0 to €3 billion, in a good year it will be €10 to €12 billion and 8 billion in an average year. In a cycle, we will have two good years, two so-so and one bad. I would say their net cash flows should be around €8 billion per year over the next 5 to 10 years.

The industry is highly competitive so, this is what one should expect. €8 billion on a €70 billion market cap implies a yield of 11%, not bad. I have to see what is the story around the €8 billion in cash flows. In the 5 year strategy plan conference webcast, the finance board member discusses how they expect to reach the 30% earnings dividend pay-out in 2020 and keep that for longer.

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Source: VOW

So, 30% of €25 is €8.3 that on a €141 stock price, would imply a dividend of 5.8%. The positive scenario would imply a €10 dividend that is still just 7% of it.

The 7% dividend yield from VOW would be a 9.1% dividend from Porsche. So, this doesn’t come even close to my required 15% return but I’ll give you another perspective.

The market’s perspective on VOW

Remember all the brands VOW has?

7 brands

Audi (NSU) is traded on a stock exchange with a market cap of €33 billion and VOW owns 99.64%.

VOW also plans to IPO Traton, the truck/transportation division, in April for €6 billion for 25% that would value the company at €24 billion. Let’s say €20 billion. Just Audi and Traton are already at a €53 billion value.

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Source: Traton

Then we have the car branks and makers; Volkswagen, Skoda and Seat, that should also be worth at least €30, €5 and €5 billion respectively. Thus, we are at €93 billion in total. And, not to forget, Porsche AG, the car maker, not the holding company.

Ferrari N.V. that spun out of Fiat Chrysler a few years back, has operating cash flows of €400 million and a market capitalization of €20 billion.

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Source: Ferrari

In 2018, Porsche AG had operating cash flows of €4 billion that would leave at least €2 billion in cash flows. Give it a Ferrari valuation and you are at €100 billion, but let’s put is at just €25 billion.

There is then the financial services, another €2.5 billion in operating cash flows that we can set a value of €10 billion on.

Lamborgini, Bugatti, Bentley etc must be worth something too. When I sum things up, I get to €128 billion. That could easily happen as it is all a valuation game. The current PE ratio is 5, bring it up to 10 and the market cap would quickly be €140 billion.

Personal opinion and conclusion

I see where the undervalued perspective comes from, but that is relative value investing and not absolute value investing focused on earnings. There are large liabilities on VOW’s balance sheet, high forward expected investments, where €44 billion will be invested in the EV trend, which make me stick to my yield expectation, where I would love at least an 15% yield, which means VOW, or PAH have to decline at least 50% for me to take a serious interest. Well, perhaps in the next recession, if not we have other vegetables to fry.

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Cie Financiere Richemont and LVMH Stock Analysis

Before starting with the analysis of LVMH and Richemont (CFR), I am going to say that there is a lot of money in the world. When luxury brands more than double, or even triple their sales over the last 10 years, like Richemont and LVMH did respectively, it means the rich are getting richer. So, will the rich get richer also in the future? If yes, then LVMH and Richemont should be great investments.

Content

Company overviews

Company fundamentals

Investment bank analysts’ reports and targets for Richemont

My investing views

Global wealth growth – a strong tailwind

Investing strategy

Company overviews

LVMH is a bigger company, more diversified and therefore some suspect more stable in case of a recession, but more about the risks part later, you will be surprised about the business impact of a recession on these businesses. LVMH’s net income in 2009 compared to 2008, dropped only 20%, but that impacts the stock as analysts always project the current into the future as we will see later.