Table Of ContentTable of Contents
Executive Summary.............................................................................2
Accounting Analysis..........................................................................4
Ratio Analysis Forecast Financials......................................................5
Analysis Evaluations.........................................................................6
Overview of ADM and the Industry .....................................................8
Five Forces Model............................................................................9
Rivalry Among Existing Firms............................................................10
Threat of New Entrants....................................................................14
Threat of Substitute Products............................................................15
Bargaining Power of Buyers..............................................................17
Bargaining Power of Suppliers...........................................................18
Characterization of Industry..............................................................18
Key Success Factors.........................................................................19
Competitive Advantage Analysis........................................................22
Accounting Analysis.............................................................................26
Key Accounting Policies....................................................................26
ADM Pension Benefits.......................................................................28
Accounting Flexibility........................................................................30
Evaluating Accounting Strategy.........................................................32
Quality of Disclosure ........................................................................33
Core Expense Manipulation Diagnostics..............................................39
Sales of Manipulation Diagnostics......................................................39
Potential “Red Flags”........................................................................43
Fixing Accounting Distortions............................................................44
Ratio Analysis Forecast Financials.......................................................45
Ratio Analysis..................................................................................45
Profitability Analysis.........................................................................54
Capital Structure Analysis .................................................................62
Extended Ratio Analysis....................................................................66
SGR and IGR Analysis.......................................................................76
Forecasting......................................................................................77
Analysis of Valuations..........................................................................80
Valuation Models..............................................................................80
Methods of Comparables..................................................................81
Cost of Capital.................................................................................86
Intrinsic Valuation Models.................................................................88
Altman Z-Score................................................................................95
Appendix..............................................................................................97
Works Cited………………………………………………………………………...114
1
Executive Summary
Archer Daniels Midland
Investment Recommendation: Over-valued, Sell 11/1/2006
ADM- NYSE $36.61 EPS Forecast
52 Week Range $23.37 - $46.71 2006(A) 2007E 2008E 2009E
Revenue (2006) $37.4 Bil. EPS $2.32 $1.56 $1.69 $1.84
Market Capitalization $22.89 Bil.
Shares Outstanding 657,250,000 Method of Comparables ADM Industry
Trailing P/E 15.25 15.14
Dividend Yield 1.10% Forward P/E 18.30 24.77
3-month Avg Daily Trading Volume 5,365,840 PEG 91.76 73.07
P/B 1.13 1.11
Percent Institutional Ownership 68% P/S 0.66 1.14
Enterprise value to
EBITDA 11.94 19.82
Enterprise value to
Recurring NOPAT 19.38 15.74
Book Value Per Share (mrq) $15.656 Valuation Estimates
ROE 13.38%
ROA 6.17% Actual Current Price $36.61
Estimated 5-yr EPS Growth Rate
Ratio Based Valuations
Cost of Capital Est. R^2 Beta Ke P/E Trailing $24.30
Ke Estimated 9.53% P/E Forward $49.57
10-year .1777 .8846 9.53% PEG Forward $29.15
P/B $35.84
P/S $63.75
Enterprise value to
EBITDA $69.49
Enterprise value to
7-year .1771 .8830 10.22% Recurring NOPAT $36.98
5-year .1746 .8754 9.28%
1-year .1728 .8732 9.53%
Published .97 Intrinsic Based Valuations
Discounted Dividends $7.25
Kd 5.8% Free Cash Flows ($1.46)
WACC 7.78% Residual Income $14.71
Abnormal Earnings Growth $17.04
Altman Z-score 3.853 Long-Run Residual Income Perpetuity $26.46
2
Archer Daniels Midland Company is one of the largest agricultural processors in
the world. They take crops and process them to make food ingredients and
renewable fuels. ADM has manufacturing facilities all over world, and has its
headquarters located in Decatur, Illinois. It was founded in 1902, and is one of
the oldest agricultural processors around. ADM’s competitors include Bunge
Limited, Cargill Incorporated, and ConAgra Foods Inc. The threat of new
competitors is low in this industry due to several factors including large capital
investments and the fact that there are few sellers and buyer, so the entrant of a
new firm would over populate the supply. Being that this industry is an oligopoly
in nature, this business leaves a relatively low amount of competitors but a high
amount of competition.
There are a few of ADM’s product that could be under the threat of substitution.
One of those products is the high fructose corn syrup, which has been
discovered to be a leading cause in the American battle with obesity, which
results in Type II diabetes. Because of its negative affects on the human body,
the use of high fructose corn syrup could decrease while the use of sugar could
increase. The other product under threat of substitution is corn-ethanol. There
is shortage a corn, resulting in researchers looking for alternative ways to
produce ethanol.
Customers in the commodity industry have the bargaining power because they
are the ones that are able to shop around and find who they would like to
purchase from. ADM has managed to be a cost leader due to its vertical
integration system they have set up. Cost leadership is crucial and is valued as a
long term advantage in maintaining customer loyalty and repeat customers.
Companies in this industry have no real potential for pure growth, so it is
important for them to have a strong customer base, which is a key success
3
factor for this industry. Another factor is being able to maintain economies of
scope, which ADM is able to do by making such large orders and keeping the
cost per unit down. It is also key for ADM to understand all the sectors of it
company to maintain specialization as a competitive advantage. This falls under
the key success factors of economies of scale and delegation of managerial
responsibilities.
Accounting Analysis
When evaluating ADM’s key accounting policies, it was important to take into
account its key success factors. ADM had several major accounting factors that
were included in its 10-K. In a commodity industry, it is important for ADM to
have derivatives and futures to set off the risk due to unpredictable weather,
planting, changes in global demand, and many other risks. Some other key
accounting policies include ADM’s employee benefit plans and pension plans,
which are good tools to give its employees motivation to do a good quality job.
Because ADM is capital intensive and has many assets that contribute to its
production, a major accounting policy for ADM to focus on is its asset write-
downs and asset abandonment.
ADM is believed to follow conservative accounting policies while preparing its
financial statements in conformity with generally accepted accounting principles
(GAAP). The quality of a firm’s disclosure on its financial statements helps an
analyst understand the business and gives a sense of transparency. ADM’s 10-K
however, did a poor job of separating the company base, though much of the
specific information is disclosed regarding the industry. Sector information is
available, but no information is disclosed about specific assets or location of
operations. Overall, ADM did not nothing special to its 10-K to make it as a
guide for investors.
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By running ADM’s sales and expense ratios, we were able to evaluate any
potential “red flags” found in its 10-K. There was only one ratio that showed
some strange results, which was the expense diagnostic of cash flow from
operations over operating income in year 2004. After some research into ADM’s
10-K we noticed that ADM had an unusually large write off that year which
depressed its cash flow from operations. Therefore, ADM had no unusual
accounting distortions.
Ratio Analysis and Forecast Financials
By analyzing ADM’s ratios that examined its liquidity and operating efficiency,
profitability, and capital structure we were able to get a better understanding of
where it stands within the agricultural processing industry, compared to
competitors. By evaluating ADM’s liquidity and operating efficiency ratios, they
showed that ADM appeared to be growing more liquid overtime, while
experiencing a decrease in its operating efficiency. The fact that ADM is losing
operating efficiency is a sign that they may lose a competitive advantage in the
foreseeable future. As for the profitability ratios, they all improve in ADM’s favor
almost every year. This illustrates management’s ability to focus and maintain
constantly increasing levels of profitability each year. When evaluating ADM’s
capital structure, we were concerned by the debt service margin, which went
through some significant changes due to volatile fluctuations in cash flows from
operations.
There are extended ratios that help get an even better understanding of how
ADM is doing and what its future may hold, which include recurring NOPAT
margin, EBITDA margin, net long-term asset turnover, PP&E turnover, operating
cash flow ratio, and dividend payout ratio. All of the ratios seemed to be in favor
of ADM, except the recurring NOPAT margin, EBITDA margin, and the operating
cash flow ratio. The recurring NOPAT margin seems be low due to the hedging
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contracts that ADM has and the volatility of commodity prices. It has been
experiencing exceptional gains, but still leaves doubt if they can maintain them.
The decline of ADM’s EBITDA margin is believed to be a direct result of the
slowing economy, but also shows that management was ineffective in combating
the slowing growth despite its dominate market position. The last ratio that
concerned us was the operating cash flow ratio which was way too erratic for a
company of this maturity. The erratic ness was due to both the operating cash
flows and the current maturities of long term debt, which is hoped to not
manifest into the future. Overall, the future of ADM seems promising with a few
issues that it should work to improve.
Analysis Evaluations
Determining whether the stock price of ADM is undervalued, fairly valued, or
overvalued can be done through several methods. Not all the methods we used
to evaluate ADM are equally reliable, so we had to go through the methods and
decide whether they were accurate or not. One of the methods that we believed
was accurate for ADM was the price to book ratio. This method gave us a stock
price of $35.84, compared with the observed stock price of $36.61, to result in a
fairly valued evaluation. Another method that we believed to be fairly accurate
was the enterprise value to recurring NOPAT margin. The estimated price of
$36.98 is the closest to the observed share price of $36.61 out of any model that
we have used due to the fact that it more accurately reflect companies that are
heavily based in fixed assets, such as ADM. Even though these methods were
believed to be the most accurate out of the method of comparables ratios, we
still do not rely on them because ADM is considered to be an overvalued
company, not fairly valued as stated in the outcome of these two ratios.
For the rest of our intrinsic value models, it was necessary for us to find the cost
of equity, cost of debt, and the weighted average cost of capital. We then
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carried on to the Discounted Dividend Model, Free Cash Flows Model, Residual
Income Model, Abnormal Earnings Growth Model, and the Long Run Residual
Income Perpetuity Model. Again, not all of these models were believed to be
accurate. We found the Long-run Residual Income Perpetuity to be our most
accurate model, with the Residual income and Abnormal Earnings Growth Models
close behind, which all resulted in overvalued estimations. Overall, we believe
that ADM should be valued lower than the observed market price of $36.61 with
a sell opportunity due to this prevalent theme across most of our intrinsic
valuation models.
7
Overview of ADM and the Industry
Archer Daniels Midland Company is one of the largest agricultural processors in
the world. It serves as one of the most important links between farmers and
consumers. ADM takes inputs and processes them to make food ingredients,
renewable fuels, and naturally derived alternatives to industrial chemicals.
Archer Daniels Midland was founded in 1902 and incorporated in 1923. ADM’s
headquarters are in Decatur, Illinois and they operate processing and
manufacturing facilities across the United States and worldwide. ADM’s
competitors include Bunge Limited, Cargill Incorporated, and ConAgra Foods Inc.
(ADMworld.com).
ADM's Total Sales (in billions)
40
30
20
Sales
10
0
2001 2002 2003 2004 2005 2006
ADM is an S&P 500 company, which gives them a valued weighted index where
they make up 2.8 % of the total S&P 500 according to share price. ADM’s sales
volume has continued to increase in the past five years ending in 2001 with 19.5
billion dollars and currently at 36.4 billion dollars. Sales grew from 2001 to 2004,
excessively from 19 billion to 36 billion then in 2005 going down to 35 billion, yet
pulling it up to its current sales of 36 billion. This gives ADM an annual growth
percentage of about 28%. Not only are they a continuously growing company,
they are the current leader in the market against its direct competitors, Bunge
Ltd., Cargill Incorporated (privately held), and ConAgra Foods Inc. With a 25
8
billion dollar market capitalization, ADM is 13 billion dollars larger than ConAgra
Foods Inc., its closest competitor. For the overall food industry, ADM is ranked
fourth of the top eight, trailing behind Unilever NV, who leads the industry, by 44
billion dollars. This puts ADM as a strong leader in the market. ADM does trail by
44 billion dollars to Unilever NV; however, ADM’s stock price is over 14 dollars
higher and they have 2 million more shares in volume. ADM asset value has
gone from 14.3 billion in 2001 to 21.3 billion in 3rd quarter of 2006. Since ADM is
growing and leading the industry, it is investing more, expanding, and increasing
its inventory. The company’s ability to lead the industry has increased its stock
from roughly 12 dollars in April of 2001 to its current closing price of 38 dollars,
with only one split of 105/100 in August 2001(MorningStar.com). ADM is a
diverse company that produces a variety of food ingredients including corn syrup,
specialty flowers, cocoa, and sweeteners. ADM also produces products such as
ethanol, fertilizer, and common household products. Because ADM has such a
wide variety of products they compete in numerous markets, including consumer
food industry, farm product industry, and bio-diesel industry (ADMworld.com).
Five Forces Model
Rivalry among Threat of New Threat of Bargaining Bargaining
existing firms Entrants Substitute Power of Power of
Products Buyers Suppliers
High Low Average Low Low
The Five Forces Model shows us in great detail the opportunities that face firms,
in a particular industry. In an attempt to analyze the profitability of industry,
there are several important areas to consider. Breaking down the analysis of an
industry into five forces allows specific attention to be given to any area in which
abnormal profits are able to be made. The degree of competition among
existing firms determines the strength of any particular company in relation to its
9
Description:Archer Daniels Midland Company is one of the largest agricultural competitors is low in this industry due to several factors including large capital.
