Summary
- ADM’s nutrition unit is under scrutiny for accounting practices potentially affecting executive bonuses, with over $70 million in question, despite contributing less than 10% to total revenue. This led to a significant stock price drop of 25% in January 2024, considered steep by the article given the unit’s small contribution to overall growth and profits.
- The broader market context includes the impact of the Russia-Ukraine war on agriculture, benefiting ADM initially but later reducing profitability as commodity prices normalized.
- Despite these challenges, ADM forecasts a modest downturn in earnings for FY 2024, with expectations of a potential ~20% upside in stock price, accounting for a planned buyback and a 3% dividend yield.
- Risk assessment highlights high commodity risks, medium risks from the outcome of the accounting probe, and the potential for ADM not to outperform the S&P 500 due to its low growth and margin profiles.
Investment Thesis
#1: The core investment thesis is that the accounting probe is transitory and ADM continues to be a stable, mature business
- For some context, ADM’s nutrition unit, contributing less than 10% to total revenue, is under investigation for accounting practices, significantly influencing executive bonuses with over $70 million awarded for surpassing profit growth targets. The board had specifically tied senior executives’ stock award payouts to the profitability growth of this segment in 2020 and 2021.
- ADM’s board in 2020 and 2021 staked a considerable share of senior executives’ stock award payouts to the profitability growth of its nutrition unit. The company blew past the goals for the first round of awards, helping the executives collect shares worth more than $70 million
- The news broke Jan 2024, dropping the price from $68 a share to $51 overnight (25% decline). Before this, ADM prices already started to see a decline due to macro economic reasons.
- We think that a 25% decline is a bit steep given that the nutrition segment only represents less than 10% revenue, and 7% of operating profits. When you look at this at a growth perspective, from 2020 to 2023, 77% of the growth of ADM’s operating income was represented by the Oilseeds Segment, 19% from the Carbohydrate Solutions Segment and only 4% from the Nutritions Segment. Even if the nutrition segment has been misreported and shows a flat or negative growth, it would still be immaterial to the bottom line
- The obvious negative downside would be the loss of investor trust but a 25% downside more than reflects that narrative
- Another significant event impacting ADM and similar companies was the onset of the Russia-Ukraine war in early 2022, which disrupted global supply chains, particularly in agriculture. Ukraine and Russia are major producers of grains and oilseeds, and the conflict led to a decrease in their agricultural output, initially benefiting companies like ADM due to increased demand for their products and higher prices
- However, by 2023, the situation began to change. Prices for agricultural products, including wheat, started to normalize, reducing the profit margins and return on assets for companies involved in these markets. This normalization of prices put pressure on ADM’s profitability and stock value, as the company’s operations are closely tied to commodity prices
- So taking a macro view, the price of Oilseeds peaked about May 2022 and dropped almost 30% heading into early Jan 2024. ADM prices dropped from $86 to $68 (pre-accounting probe) per share, representing a drop of 21% in the same time frame. Grain prices still have about 20% to drop until it hits it’s normalized 2015-2019 levels.
- So putting it together: For FY 2024, ADM said it forecasts earnings of $5.25-$6.25/share, down 18% from 2023 due to lower margins and higher costs but in line with $5.41 analyst consensus estimate. Forecasting PE to be around 12 in 24′ and accounting for a $2bn buyback (approx. a 6% upside), we give a target of $73, a ~20% upside from March 19 close price of $61. In addition, there’s a 3% dividend yield return.
- There’s still a lot of volatility in the next few months but the 2 specific focus areas would be (1) How grain prices are tracking and is it continue to project a 20% decline in 24′ and (2) Outcome of the accounting probe
Risk Assessment
- High Risk: Commodity risk where grain prices normalizes sooner than forecast, causing a 20-30% drop in operating earnings within a year and significant headwinds ahead
- Med Risk: Accounting probe comes out to be more unfavourable than currently predicted. Examples could be that the accounting inconsistencies go beyond the Nutrition segment, the Nutrition segment is performing significantly worst than reported and/or the fine imposed by the DOJ is financially material to ADM
- Med Risk: ADM is not a business that is likely to outperform the S&P 500. The current headwinds poses a significant upside potential, but if the above risks or any unaccounted for risks occur, ADM is not (by our definitions) a long-term hold given it’s low revenue/operating growth combined with a low gross/net margin relative to the rest of the S&P 500.