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Why Monsanto's Buyback Announcement Didn't Excite Me

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Seed giant Monsanto (NYSE: MON  ) has just authorized another share-buyback program worth $1 billion, effective next month. The program will follow the last $1 billion repurchase announced in June 2010, which is about to get completed soon. Mr. Market liked the idea and took the company's stock close to its 52-week high. Rightfully so, because buybacks are ideally supposed to indicate that the shares are worth more. But given the high price of its shares, I'm not too convinced. I like the move, but not the timing.

Too pricey
A company can be said to have executed a good bargain if it buys its shares when they're trading low. That doesn't really hold good in Monsanto's case. With shares trading dangerously close to their 52-week high, and at 22.4 times earnings, Monsanto is anything but cheap. Take a look at its peers in comparison. DuPont (NYSE: DD  ) , the chemical king that's gradually transforming into an agriculture giant, is trading at a P/E of just 13. And Syngenta (NYSE: SYT  ) , which is largely into crop protection and the seed business, is trading at 18.4 times earnings. Nor is Monsanto looking like a bargain at current prices given its estimated growth of 10.75% annualized over the next five years.

Lessons from the past
Maybe management got excited after the success of its previous repurchase program. From June 2010 to now (i.e., during the time frame of the existing program), Monsanto's shares have gained a whopping 60%. But going for a share buyback didn't seem wrong then, because by June 2010, the company's shares had shed 38% since the beginning of that year.

The point is that the chance of gains is higher when shares are bought at low prices. To offer another example, Monsanto ran a buyback program between April 2008 and August 2010. It wasn't timed right, because by April 2008, shares had climbed a staggering 88% within a year. What happened? By the time the program ended, Monsanto's shares had lost more than half their value. Clearly, Monsanto's buyback transactions in the past few years have been less than spot-on.

Why not dividends?
Still, returning value to shareholders seems to be one of the best things Monsanto could do. The company is flush with cash, with a balance of more than $2.5 billion and unlevered free cash flow of more than $2 billion. It's generating higher cash flows than net income. And a total debt-to-equity ratio of 18.3% means there's little need to keep cash tucked away for debt obligations. Solid operational performance is further solace. So rewarding shareholders is a great idea.

So why not pay a higher dividend, then? The most obvious reason is that once a dividend is increased, no company likes to cut it later on. It will always try to maintain it or raise it, which is why dividends are a long-term commitment on the company's part. Monsanto is currently paying out more than 30% of profits, but the stock only yields a modest 1.6%.

The Foolish bottom line
Maybe a special dividend could be the answer. At least waiting to execute the latest buyback till the shares were better-priced would have made more sense. I don't doubt the financial strength of the company; it's all about timing the moves right. In any event, you can stay updated on Monsanto's plans by adding it to your stock Watchlist.

Share buybacks or dividends -- what's your pick? Share your comments below. And if you prefer the latter, I also invite you to read our special free report: "Secure Your Future With 11 Rock-Solid Dividend Stocks." Access your copy today at no cost! Discover the winners we've picked.

Fool contributor Neha Chamaria owns no shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended creating a modified stock repair against synthetic long position in Monsanto. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (2) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 10, 2012, at 8:30 PM, funfundvierzig wrote:

    Very good analysis!

    As a long-term and richly rewarded MON shareholder, we would prefer an increase in the cash dividend.

    That said, Monsanto has effectively hiked its dividend each year for the past decade. In contrast, its major rival DuPont has raised its dividend only three times in the last 14 years and then only by modest percentages. ...funfun..

  • Report this Comment On June 12, 2012, at 8:23 PM, Camacam wrote:

    Watch the change in tax law. If the 15% tax rate on dividends is raised or somehow tied to income level, the buyback route is going to gain more of a following. If the 15% rate is left as is, I'd rather pay the tax and have a little ash in my pocket.

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