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Archer Daniels Midland: Unless You Can Time Momentum, Sell Now


Given volatility and the current valuation, this may be as good as it gets.

Archer Daniels Midland (NYSE:ADM) is now efficiently valued on next year's earnings, which are at a normalized level. Given the volatility of the stock, in my opinion, it's best to sell.

Now is a good time to reread my original article published in late March: Why ADM is a Buy Right Now.

Archer Daniels Midland's report of an adjusted $0.46 for the third quarter was only what Wall Street expected, but the first very good corn crop in a few years came in; soy bean processing in Brazil is good, with more planted acreage expected next season; and management was optimistic on the call -- all being enough to put a point and a half on the stock price. Combine that with a management that is cutting back on capital spending and investors can expect higher returns on capital, something they have hoped for over some time. So, the result could be some combination of record EPS, an ROIC above the weighted average cost of capital, and even some buybacks 12-plus months out. One sell-sider commented that some bulls see $4 as possible.

The one depressant to that is that the sell side's 2014 and 2015 estimates are about the same, at $3.17 and $3.19, which are about equal to my $3.25 estimate of normalized earnings per share. That may change if investors get more confidence that the Grain Corp. acquisition will work well in the shorter term, but ag services and processing stocks are too volatile to make waiting worth the risk.

Ethanol should remain in oversupply, so no upside here.

Mexico could end up taxing high fructose corn syrup and sugar, which would obviously not be a positive.

A potential upside would be the evolution to a lower risk profile, which I explained in my buy recommendation as a movement to a 6 or 6.5% risk premium over time from about 7% now.
That 7% is clearly too high longer term as I pointed out in my buy recommendation. ROIC should be above the weighted average cost of capital in the next year, and CEO Patricia Woertz has already been raising capital spending hurdles, which means that ROIC should then stabilize at above the cost of capital. I believe that this will be a trigger for a 6.5% or lower risk discount to be awarded by investors.Getting to 6.5% would be another 5% appreciation, maybe over 12 to 18 months; again, this would be too little reward coming over too small a time period and so will likely be swamped by stock volatility in this industry, though it may be what I use to value the stock when I next recommend it.

So, at $41, the stock, using two consecutive next-twelve-month EPS estimates of $2.71 and $3.17, a 7% risk discount, and a 4.2% risk-free rate (3.6% 30-year Treasury bond + 60 bps of leaning against the Fed's quantitative easing), the stock is discounting an 8% five-year growth rate, well over the 5% which I would estimate.

Leave it to the momentum traders.
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No positions in stocks mentioned.
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