Archer-Daniels-Midland Company (ADM) Earnings Call Transcript & Summary

Hello, everybody, and welcome to the JPMorgan U.S. All Stars Conference. My name is Tom Simonitsch. I'm a research analyst here at JPMorgan. We're delighted to host Ray Young, CFO of Archer Daniels Midland. I know that Ray has some opening remarks so we're handing over to him very quickly. ADM has a market cap of $26 billion. The stock has performed in line with the broader market year-to-date with total shareholder returns of 5% versus the S&P 7%, and we have a neutral rating. With that, Ray, thank you so much for joining us. Over to you. Sorry, Ray, I think you may be on mute.

Sorry about that, Tom. So good morning, everyone, or good afternoon, everyone, and I appreciate the invitation from JPMorgan to participate in this conference here. I always look forward to coming to London for the September conference with JPM. And hopefully, next year, I'll be able to participate in person in order to meet with everyone there. For those who aren't as familiar with ADM, our purpose is really to unlock the power of nature in order to enrich the quality of life. We are one of the world's largest nutrition companies with more than 800 facilities around the world, offering an expansive pantry of ingredients and solutions to meet both human and animal nutrition needs. We also serve a critical role as being a key global supply chain manager, linking the areas of net food production to areas of net food consumption. We take our role very seriously, providing nutrition to the world and work hard to keep our promises, especially this year in a COVID-19 environment. We've kept all our colleagues safe. We've kept our 800-plus facilities operating throughout the pandemic, and we kept on serving our customers around the world. Even as we focus on our safety of our customers, we've simultaneously continued ADM's transformation into really a purpose-driven company that's more technology-enabled, more agile, more innovative, more global. It's greater capabilities to meet customer needs across the entire value chain. And as I kind of reflect upon the first half of this year, I'm very proud of the actions the team have taken as part of our strategy to enable us to deliver exactly what we said we're going to do at the beginning of the year. Now so looking just briefly at our financial results. First half segment operating profit, up 12% versus 2019; adjusted EPS, up almost 50% versus 2019. And we've maintained a very, very strong balance sheet throughout the period as well as strong liquidity position. We're building a global leadership position in Human Nutrition and Animal Nutrition. In this segment, which is our newest segment, first half operating profit growth of over 50% with the entire portfolio demonstrating strength And with the recent acquisition of Neovia in Animal Nutrition last year, we're ahead of our synergy targets right now, and we continue to improve our EBITDA margins in that business. And then we continue to advance our growth algorithm in terms of things that we can control, which includes improved harvest and then the Readiness Initiative, which we're on track to exceed the $1.2 billion run rate target that we established 1.5 years ago. So we're really in a strong position to deliver value for our shareholders. Now looking ahead to the rest of this year, I do expect strong performance for ADM in the back half of the year. We do expect China to continue sourcing agricultural and food products from United States as, frankly, as Brazil has really depleted most of their inventories with soybeans. And China, with the economy recovering, they basically need additional products. Barring another broad-based lockdown of our economies, I do expect the sweetener and fuel ethanol demand to improve from this trough in the second quarter. And I do expect the Nutrition business to continue to deliver in the back half of the year, 20% plus operating profit improvements versus the second half of '19, with a strong pipeline continue to deliver good growth in our business. And then, lastly, we do expect to achieve our $500 million to $600 million of improvements. There are things that are under more our control versus last year. So in my mind, our success only reinforces our commitment in order to really allow ADM to be really delivering on its promise to really provide nutrition to the world in good times and bad times. With that, let me hand it over back to you, Tom, for our Q&A session. So thank you.

Thanks, Ray. If we can begin with the short-term outlook and the various negative impacts of COVID-19, demand for fuel, foodservice demand for cooking oils and sweeteners. How is the recovery from April days compared to your earlier expectations? And if you could then address some of the tailwinds you've experienced through the pandemic, how sustainable is the growth in wheat milling, industrial starches, et cetera?

As I indicated in my opening remarks, we've been able to manage through the first half of the year quite well through the COVID-19 environment. And we clearly have had puts and takes across our business line. When you take a look at probably the segment that's been most impacted from a headwind perspective, it's really the Carbohydrate Solutions business. And so in this business, which is both the corn processing business and the wheat processing business, we've seen headwinds with respect to demand, first of all, in terms of our Starches and Sweeteners. So with the foodservice sector shutting down in most places around the world in the month of March and April and in United States, especially after the middle of March, a lot of restaurants shut down, sporting events shut down, we've seen a decline in terms of sweetener consumption and corn-based sweetener consumption as well as certain types of starch consumption. The shelter-in-place orders that we've seen in many states around the country resulted in people not going to work. And so therefore, paper consumption, office paper consumption, whether it be printing paper or copying paper, went down. So that had an impact on the industrial starches side of the business. So we clearly had headwinds in terms of our Starches and Sweetener businesses in the second quarter. We've seen, in addition with the shelter-in-place orders, we've seen gasoline demand collapse, down almost 50% in the month of April and early May, and that had an impact on our ethanol business. Because in the United States, ethanol is blended with gasoline in order to become transportation fuel. So those are, Tom, the biggest, let's say, headwinds that we've seen in our business due to COVID-19. I do believe that the trough demand has recovered. We've seen evidence of recovery already in June, right, in terms of transportation and fuel demand. And even as restaurants are opening up in the United States, especially QSR, so the so-called quick service restaurants, we're seeing some recovery in terms of sweetener demand as well. So as I kind of reflect upon the Carbohydrate Solutions business, the team has done an exceptional job managing costs in the business. They've done an exceptional job in terms of risk management in that business. I do believe the second half of the year for Carbohydrate Solutions, even with the headwinds that we've experienced, we should be able to see these headwinds diminish and have a stronger second half of the year for that business. And that business also did have some tailwinds. And you mentioned wheat milling, right? So flour demand in the United States actually was actually quite strong in the first half of the year as people stayed at home and did a lot of home baking. So retail flour demand was strong and as a result, our wheat milling division actually did very, very well. We did have certain tailwinds in the first half of the year. I made the comment to many investors that a lot of countries around the world in terms of food supplies, they moved from effectively a just-in-time philosophy of buying food to a just-in-case philosophy, meaning that they want to build up a little bit of reserves in their country not knowing how the supply chains will react through the COVID-19 environment. And so Ag Services and the global trade division clearly benefit from that in terms of incremental business. And we seem to -- for example, destination marketing margins improved in the front half of the year. So clearly, we have seen tailwinds in certain parts of the business. Our newest business, Nutrition, it's predominantly -- a lot of the ingredients that don't predominantly into products end up in the retail segment. So it's been least -- it's not been that dramatically impacted in the first half of the year by COVID-19. In fact, with a lot of the CPG companies doing very well and a lot of our ingredients going into CPG products, we benefited in that respect from COVID-19.

Okay. Great. And sticking to the near-term just for a moment. You mentioned in your prepared remarks that as Brazil's supply has tightened. What are your expectations for Ag Services in Q3 versus Q4? And then how you see crush margins into 2021?

As I indicated, Brazil has been very aggressive in terms of selling their crop to the world in the first half of the year. And especially to China, as China has been aggressive in terms of sourcing soybeans from Brazil. So Brazil had the benefit of a larger crop. They had a benefit of a weakening real, which actually encourage farmers in order to be aggressive sellers. And you had aggressive buyers, namely China. So the environment was actually very healthy in the first half of the year for our Ag Service division, particularly in the origination part of the business, particularly from South America. As you move into the back half of the year, the world will switch in terms of its sourcing from South America to North America. And as we indicated, the -- Ag Services North America progressively will improve in terms of volumes and margins and profitability as we move to Q3 and then into Q4. Q4 will be the strongest, there's no doubt about it, with a sizable U.S. crop that is expected to be harvest. So even with some of the rain chill, the wind storms that we've experienced, yields in the United States, on average, are still going to be very strong. So we're expecting a large crop in the United States. We expect Brazil will not be able to supply the world. And that's typically the case from a seasonal perspective, but more so than ever this year. And then China remains very aggressive in terms of sourcing products from North America, from United States, partly due to the Phase One, but partly due to the fact that they need the product in order to meet the requirements of their domestic economy there. And so our expectation for Ag Services in the back half of the year is actually a very positive outlook. We made that commentary at the second quarter earnings call. Our perspective remains the same, that Ag Services will progressively improve as we kind of move through the year there, both volumes and margins. And we also made the comment on the earnings call that the U.S. industry in total for the fourth quarter, we expect the U.S. industry in terms of exports of agricultural products probably hitting a record volume in the fourth quarter of this year. Your question on crush margins in the oilseeds business. This has been also a very strong performance by the oilseeds group. First half of the year, they managed through the disruptions of the animal -- the meat packing process and plant disruptions in the United States. They managed through that issue. We've seen a little bit of volatility in terms of crush margins due to that. But the meat packing plants, more or less, are running right now. And so therefore, the demand scenario for soybean meal is actually quite strong. When we talk about the back half of the year, we expect soybean meal demand from the United States to remain very, very strong, partly due to the fact that, again, Brazil is running short of beans, and so they're not going to have competitive meal coming to the markets. Argentina, which traditionally is a major exporter of soybean meal, they've got some challenges with Argentine farmers holding back the soybean crop as a hedge against devaluation of the currency. So Argentina is not going to be that aggressive in terms of the export markets. And so the global meal buyer will be coming to the United States in the fourth quarter, third quarter or fourth quarter in order to source its meal. As we kind of reflect upon moving into the first part of next year or 2021, we think that the meal demand scenarios are going to remain very, very strong. We are seeing the global economies recovering, foodservice opening up. We're seeing that oil demand or vegetable oil demand remaining very strong and partly due to the fact that for many countries around the world, biodiesel mandates, biodiesel blending is increasing, resulting in a pull on vegetable oil. And you actually see that reflected in terms of vegetable oil prices recently, whether it be soybean oil prices, palm oil prices, even sunflower oil prices. We've seen an increase -- significant increases in the price of vegetable oil -- the entire vegetable oil complex. So we actually think this scenario will -- unfolding for us in 2021. For crush at the beginning of the year, it looks pretty favorable also for our industry.

Great. I want to push you a little bit on the U.S.-China trade side of things. The USDA is now forecasting just $18.5 billion of U.S. ag exports to China in fiscal '21, which is growing year-on-year, but clearly well short of the $40 billion commitment set out on the Phase One agreement. So will that level of export support your current expectations for the fourth quarter and into 2021? Or were you expecting something closer to the $40 billion average?

So it's interesting. We saw that USDA report also. And when we looked at the numbers there and the components that make up the number, there seems to be a little bit of a not exactly an apples-to-apples comparison in terms of how this report, this specific report measures agricultural products versus how the Phase One measures agricultural products. So there's a little bit of a difference in terms of both the components of the makeup and then also the timing of the measurement. But set that aside, I mean, just -- again, a refresher for those who haven't been following phase -- the trade agreement as closely. The commitment under Phase One was $80 billion of agricultural purchases over 2 years with the first year around $36.5 billion. I think, Tom, you know that very, very well. But this is for the benefit of the audience here. And the number that was quoted, $18.5 billion, again, when we look at it, there doesn't seem to be an apples-to-apples comparison. But I think when we take a look at what's actually been happening this year versus some months of the year, we're at $10 billion of purchases of U.S. agricultural products. So still short of the $36.5 billion. But as you know, the purchases by China from the United States are very much tilted towards the back half of the year when the soybean crop, when the corn crop is available. So what we've seen so far has been very aggressive buying on the part of China from the United States, and we've seen aggressive shipments now from United States to China as again, as the world shifts from South America sourcing to North America sourcing. So we do believe that China is very, very serious about sourcing from the United States. We believe that the demand environment in China for food has improved significantly as their economy recovers. The demand environment for soybeans and -- required to crush into soybean meal is also increasing because, frankly speaking, African swine fever, which we've talked about over the past couple of years, that's getting behind China and the domestic hog herd is rebuilding in professional farms, which require a lot more soybean meal to be fed for the animals. The other comment to make on Phase One is we have seen that China has been making good progress on permanent structural changes that will allow for greater U.S. exports now and into the future. And addressing 50 of the 57 identified areas that were really maybe hindrances towards U.S. agricultural exports, including the elimination of the ban on U.S. poultry, allow additional products to be imported, regionalization protocols for avian influenza outbreaks and easing certification processes. So I think China has done, not just on the purchase side of agricultural project -- products, but they've done also reforms in terms of regulations, making it easier for us to export to China going forward. So when you ask the question, $18.5 billion, which is what the USDA report -- that specific report said versus kind of getting up to a $40 billion type of number next year, again, it's tough to do the comparison. My only comment is, my expectation is that with the China economy recovering, demand remaining strong, they've shown evidence, clear evidence that they want to try to support the U.S. agricultural industry with purchases. And even next year, just a reminder, the expectation is they're going to be buying a lot more corn from the world, which means United States would be a major source of the corn just because of the China corn crop this year has been not as strong as what they would have liked, and they also need to build up their reserves there. So I do think 2021 should be another strong year in terms of exports from United States to China. Now whether we actually hit those numbers, we'll have to see how the measurement comes, like how this kind of unfolds in terms of the actual accounting, the accounting numbers for the exports consistent with how they're measuring Phase One.

Understood. Thanks, Ray. Maybe let's shift to the longer-term outlook then. You've delivered 8.1% ROIC on a trailing 12-month basis. How and when do you get to your 10% ROIC objective? And in particular, if you could elaborate on your growth strategy in Nutrition.

So we publicly communicated our long-term objective and returns is 10% ROIC, and we're running above 8% right now. So we're on our trajectory towards getting there and with a long-term cost of capital of 7%. So therefore, our long-term objective is to earn at least with a 10% ROIC, a 300 basis point spread over our long-term cost of capital. From our perspective, we made good progress. So when we think about 10% ROIC, it requires us to work on both the numerator and the denominator. So from a numerator perspective, we continue to drive improvements in terms of earnings. The Readiness Initiatives, I talked about the $1.2 billion run rate in terms of Readiness benefits, which again, for those who haven't been following us that closely, this is really a continuous improvement program in terms of improving how we execute within the company. So it's not just a cost reduction program. It's an overall profit improvement program. And again, we feel good that, that program is not going to stop by the end of 2020. It's going to continue in 2021, '22. That's going to be a contributor towards our top line growth. Secondly, we continue to harvest investments. And we've made a lot of investments over the years, both large acquisitions, such as the Neovia acquisition, but also smaller investments as well as organic growth investments, a lot of it, as you point out, in the Nutrition space. And so we're going to continue to harvest these investments and reap the benefits of these investments, and that's going to allow us also add to the top line. Specifically, as it relates to Nutrition, we've got a lot of momentum in the Human Nutrition business with the WILD Flavors acquisition. That's really helped us create the Human Nutrition platform. We've got momentum as basically we start integrating flavors into food systems for our customers there. On the Specialty Ingredients business, that trend towards plant-based proteins is very strong, especially in the COVID-19 environment right now. We've seen strong demand for plant-based proteins, alternate proteins. Our Specialty Ingredients business, by the way, is the largest producer of alternative proteins or plant-based proteins in the world. And so we recently -- you probably recently saw this joint venture that we've announced with Marfrig of Brazil to be able to basically supply plant-based proteins in North America and South America, whereby we'll provide the innovation, R&D expertise, and then Marfrig will provide the manufacturing and the distribution capabilities in the joint venture here. So that's going to allow us also to further grow the Nutrition business. And then lastly, the Health & Wellness business in Human Nutrition, which is the third part of our Human Nutrition platform, is the fastest-growing part of our business. This is a business that gets involved in prebiotics, probiotics and postbiotics is really this area of healthy, healthy ingredients, things that help the immune system. Especially in the COVID-19 environment, there's strong demand for these products, and we expect this platform, which is probably our smallest platform in Human Nutrition, will continue to grow. And don't be surprised if we do some bolt-on acquisitions there in order to further strengthen and upsize this part of the business. And then as Animal Nutrition with the Neovia acquisition, that's a business whereby we've increased the margins. When we bought Neovia, EBITDA margins were in the low single digits. We've already increased it to the high single digits. So the EBITDA margin expansion plan continues with Neovia. But then on a broader basis for Animal Nutrition, the same play that we did in Human Nutrition with the WILD Flavors, we're going to do the same thing on the Animal Nutrition side with Neovia and integrating Neovia with our ADM Animal Nutrition business. So I feel very good about the top line growth prospects that will drive us towards the 10% ROIC. On the denominator. We've been very much focused on being very prudent on capital, right, especially for our traditional businesses. So an initiative called precision EVA, whereby in Ag Services & Oilseeds, we've been very prudent in terms of how we look at our asset footprint. And we've done a lot of work, frankly speaking, in terms of pruning our asset footprint, selling elevators, doing joint ventures, shrinking basically invested capital base required to run the Ag Services & Oilseeds business. And similarly, in Carbohydrate Solutions, we've consolidated a lot of our older plants in the wheat milling business, shrinking the footprint, consolidating into more efficient plants and getting a better cost structure, while at the same time, getting the similar amount of output of these plants. So we're working on the denominator side as well. So when you add the growth in the numerator and being very prudent on the denominator, that allows us really to get towards the 10% ROIC target over the next 5 years.

Great. There's quite a lot unpack there. Maybe just on the Animal Nutrition margins, how quickly can you grow those margins towards your current margins in Human Nutrition? And is there any sort of structural reason why they should be lower going forward?

The animal nutrition business, as I indicated, we've grown, for example, in Neovia, margins up to the high single digits. We probably won't get these up to the Human Nutrition margins for the simple reason that within our global Animal Nutrition business, there are certain parts of that business, which are probably more commodity like. And for example, lysine. Lysine is a part of our Animal Nutrition business. It's probably more commodity like in terms of its margin structure. And as you know, the Chinese players are major participants in the lysine markets around the world. And hence, they do have an impact in terms of the pricing environment for lysine. So if you set aside some of the commodity-like aspects of our animal nutrition business, like lysine and compound feed, if you look at the rest of the business, we do believe that we'll be able to grow those margins up into the -- going from the low single digits into the low double digits and maybe into the mid-teens. And so there is going to be concerted effort to drive that, which will be a combination of additional cost reduction actions. And we've done a lot already, but there's more to be done on the cost reduction side. But more importantly, on the revenue side, which is a combination of mix management. So managing the mix of the products, managing the product portfolio and then also then driving innovation in terms of coming up with new products that have higher margins, which is effectively what we did on our Human Nutrition business as well. And then, lastly, this aspect of movement towards a systems approach towards selling ingredients, which we've done on the Human Nutrition side, we'll be doing that also on the Animal Nutrition side, and that will also help support the margin expansion in that business there.

That's very helpful. And then you mentioned your joint venture with Marfrig. I know you have other initiatives in plant-based foods. How big is that business for ADM today? And how big would it be in 5 years' time?