- Archer-Daniels-Midland reports Q1 results on Apr. 26
- Shares have rallied on rising inflation
- Current stock price is well above the consensus 12-month price target
- The market-implied outlook is neutral to slightly bearish to early 2023
Archer-Daniels-Midland (NYSE:ADM), the Chicago-based agricultural commodities giant has performed very well over the past year, as global inflation surged.
Shares in the firm have returned a total of 68.1% over the past 12 months and 44% so far in 2022. While much of the rally in 2021 and 2022 is attributable to the impacts of inflation, realized and expected, ADM has gained far more than the farm products industry (as defined by Morningstar).
Source: Investing.com
The Chicago, Illinois based multinational has beaten expectations on quarterly earnings for 10 consecutive quarters. For the 2 most recent quarters, Q3 and Q4 of 2021, EPS exceeded the consensus expected level by more than 9%. In Q1 and Q2 of 2021, reported EPS beat the consensus by about 30% (33% in Q1 and 29.4% in Q2).
The consensus expected EPS for Q1 of 2022 is almost identical to reported earnings in Q1 of 2021. With the surge in earnings largely attributable to inflation, it is not surprising that earnings are expected to fall over the longer term. The expected EPS growth over the next 3 to 5 years is -1.8% per year.
Source: E-Trade. Trailing and estimated future quarterly EPS for ADM. Green (red) values are amounts by which EPS beat (missed) the consensus expected value.
Q4 profit was up by 26% (Slide 8) benefiting from rising food prices and rising demand for ethanol (Slide 7). The question is whether the shares have risen to the point that expected gains from inflation are fully priced in.
On Oct. 13, 2021 I maintained a bullish/buy rating. From that date until now, ADM has returned a total of 55.9% vs. 1.6% for the S&P 500. When I wrote this post, the Wall Street consensus outlook was bullish but the price was only a few percent below the consensus 12-month price target. The shares had gained strongly for the year, to the point that the shares were close to fully valued, based on analyst opinion. A key factor in my decision to maintain my buy rating, even after the substantial gains, was that the market-implied outlook, reflecting the consensus view from the options market, was signaling that the upward momentum would persist.
The price of an option on a stock reflects the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing prices of call and put options at a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price forecast that reconciles the options prices. This is called the market-implied outlook and represents the consensus view among buyers and sellers of options. For readers who want more information than I provide in the previous link, I recommend this excellent monograph from the CFA Institute. In October, the market-implied outlook for ADM was bullish to early 2022, shifting more neutral towards the end of Q1.
Inflation has surged since my last analysis of ADM, and the shares have risen substantially. I have updated the market-implied outlook and compared it with the Wall Street consensus in revisiting my rating for ADM.
Wall Street Consensus Outlook for ADM
E-Trade calculates the Wall Street consensus outlook by combining the views of 7 ranked analysts who have published ratings and price targets over the past 3 months and its consensus rating is bullish, but the consensus 12-month price target is 16.4% below the current share price.
This disconnect between the qualitative rating and the expected return is mainly due to ADM’s massive gains in recent months. This suggests that the shares are overbought, even though it is expected to continue to deliver strong results.
Source: E-Trade
Investing.com’s version of the Wall Street consensus outlook is calculated using the views of 15 analysts and is consistent with E-Trade’s results. The consensus rating is bullish and the consensus 12-month price target is 20.4% below the current share price.
Source: Investing.com
The Wall Street consensus outlook makes sense in light of the huge share price gains in recent months. Having the current share price so far above the consensus price targets definitely suggests caution.
Market-Implied Outlook for ADM
I have calculated the market-implied outlook for ADM for the 9.1-month period from now until Jan. 20, 2023, using options that expire on this date.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from E-Trade
The market-implied outlook for the next 9.1 months is tilted to favor negative returns, with the peak in probability corresponding to a price return of -4.9%. The expected volatility calculated from this outlook is 30% (annualized).
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).
Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.
This view shows that the probabilities of having a negative price return over the next 9.1 months are consistently higher than the probabilities of a positive return of the same magnitude, across a wide range of the most probable outcomes (the dashed red line is above the solid blue line over the left half of the chart above). The market-implied outlook appears somewhat bearish.
Theory suggests that the market-implied outlook is expected to have a negative bias because risk-averse investors pay more than fair value for downside protection (e.g. put options). There is no way to measure if such a bias exists, however. Considering that a negative bias is expected, however, leads me to interpret this market-implied outlook as neutral with a bearish tilt rather than moderately bearish.
The market-implied outlook is more bearish than in my analysis from October. I also calculated the market-implied outlook over the 2 months until June 17, 2022 and the results were qualitatively similar so I did not include the chart here.
Summary
Archer-Daniels-Midland has delivered strong earnings in the inflationary environment of the last 12+ months and investors have bid up the share price in response. As a result, at current levels, some degree of irrational bullishness is apparent.
The Wall Street consensus rating continues to be bullish, but the share price is around 20% above the 12-month price target. The market-implied outlook to early 2023 is neutral with a bearish tilt. The expected volatility, 30%, is higher than in my previous analysis (25%-26%), and the current market-implied outlook is less favorable than it was back in October.
While ADM is well-positioned to continue to thrive, with high fuel and food prices in the United States and beyond, I am changing my rating from bullish to neutral because the shares have so much anticipated earnings upside reflected in the current price.