Horizon Kinetics is Bullish on Archer Daniels Midland (ADM), Bearish on Mcdonald (MCD)

Horizon Kinetics LLC, a New York-based investment advisory firm founded in 1994, released its Q1 2020 Commentary – a copy of which is available for download here. It has over 70 employees and is led by Murray Stahl. Its investment strategy is long-term and contrarian oriented, and the fund usually holds a concentrated portfolio with original stock picks.

In the said letter, Horizon Kinetics spoke about Archer Daniels Midland Co (NYSE:ADM) and Mcdonalds Corp (NYSE:MCD) stocks. Archer Daniels Midland is a global food processing and commodities trading corporation based in Illinois. Mcdonalds is a fast food company based in Illinois. Here is what Horizon Kinetics said:

“We were asked about the attractiveness of some well-established, low-price-point restaurant chain, like McDonald’s. It would seem to be a high-quality name for maybe a consumer-income-constrained world. The share price had dropped in lock step with the S&P 500. The problem is that inflation isn’t evenly applied. If it were, if all prices and salaries and rents rose by the same percentage, it’s not a problem. But what if McDonald’s input costs, like wages and rents, as well as the prices it charges its customers, are all rising at a 6% annual rate, but suddenly the cost of beef rises by 12%; and the cost of corn syrup for soda? Food and packaging are roughly 30% of a fast food restaurant’s costs. That could seriously diminish profit margins.

A better business model for such an environment might be a food processor like Archer Daniels Midland. The country can’t exist without an ADM. It would be difficult to have a balanced dinner without some ADM product on your plate, whether it’s the vegetable oil in the salad dressing, the protein meal that fed the chicken, the wheat flour and yeast in your bread, the citric acid in the spice rub, or the probiotics in your health drink. The company has its own trucks, railroad cars, river barges and ocean-going vessels.

A negative of the business is that, as an intermediary, ADM has very low margins: a 6% gross margin and 2% net margin. A positive, though, is that it is a very high-quality business that has staying power: it has a credit quality rating of A and it hasn’t missed a dividend payment in over 80 years. The other positive is that it can benefit mightily from just a bit of inflation, because even if it can expand its net margin by only, say 2% points, that’s a 100% increase in earnings. The stock can do exceedingly well under those circumstances, particularly if it can put 2 good consecutive years together. In 1992, its gross margin was about twice as high as today and the net margin 2 ½ x higher. So, in principle, ADM could be a candidate for us. The challenge, though, is that it is such a diverse business that there is hardly a year when it doesn’t have some sort of problem that offsets the success of the other parts of its business, say root rot in the soybean crop. So that requires some thought. Maybe it’s the right company but not the right time. Maybe it is the right time.

But it gives you an idea of how we’re thinking about business models vis-à-vis an inflationary environment.”

In Q4 2019, the number of bullish hedge fund positions on ADM stock increased by about 22% from the previous quarter (see the chart here).

In Q4 2019, the number of bullish hedge fund positions on MCD stock increased by about 10% from the previous quarter (see the chart here).

Disclosure: None. This article is originally published at Insider Monkey.