Are You Ready for Monsanto's $1 Billion Herbicide Factory?

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Hugh Grant, the CEO of Monsanto (MON), recently updated investors on ongoing potential merger and acquisition discussions with industry peers by simply saying, "It's clear that Monsanto remains the partner of choice in this industry." I don't think the company should sell itself for just that reason. Compared to industry peers, Monsanto has the pipeline with the most potential and growth projects. To top it all off, MON has the most near-term benefits for shareholders. 

One of these near-term growth drivers that investors should have on their radar is a manufacturing facility in Luling, Louisiana, where Monsanto is investing $975 million to become a leading producer of the herbicide dicamba. While the entire industry currently produces enough dicamba every year to cover about 40 million acres of farmland, the manufacturing facility in Luling will boast an annual production capacity covering between 80 million and 100 million acres of farmland. Some of the production will be sold to DuPont (DD) for its proprietary herbicide formulations, while the remaining capacity will be sold under Monsanto herbicide brands.

In other words, the planned herbicide factory is kind of a big deal. 

Why manufacture dicamba?

Dicamba is not a new herbicide by any means. In fact, it has been used to control broadleaf weeds in the United States since 1967. But the herbicide is on the cusp of a renaissance as agrochemical companies aim to deliver new weed control solutions into the hands of farmers dealing with increased tolerance to the most widely used herbicide, glyphosate. While weeds were developing tolerance to herbicides long before the introduction of genetically modified seeds, the near-ubiquitous use of agricultural biotechnology in major crops has increased selective pressures for such traits to develop. The industry's answer: more agricultural biotechnology. 

That really shouldn't be too surprising. Much of Monsanto's success in the past two decades has been derived from developing and licensing genetic traits that allow corn, soybeans, cotton, and other crops to tolerate applications of glyphosate. The company may be closely associated with the sale of glyphosate herbicide formulations sold under the Roundup brand, but most of the company's revenue and profit is actually derived from selling seeds and licensing genetic traits, as full-year 2015 financials demonstrate:

Note: Herbicide performance reported under agricultural productivity segment. Data source: SEC filings.

Given the rise in glyphosate-tolerant weeds, Monsanto has also been quietly developing genetic traits that allow major crops to tolerate applications of dicamba (and new herbicide formulations that go hand-in-hand with the new traits). Investors already know how this will play out: direct seed sales under brands marketed by the company and traits licensed to industry peers.

But there's a slight twist to how the genetic trait for dicamba tolerance, called Xtend, is being deployed. Rather than being rolled out as a separate technology platform, Monsanto is viewing it as an upgrade to its existing Roundup Ready technology platform. That means, simply, the company is selling seeds that tolerate both glyphosate and dicamba herbicide applications -- marking the first commercially available stacked trait (two or more traits in the same seed) for herbicides. 

Soybeans are the first crop to include the Xtend trait, which Monsanto is selling as a stacked trait under the Roundup Ready 2 Xtend brand. There are currently roughly 1 million acres of the crop deployed in the United States today, although the company expects market penetration to grow to 15 million acres in 2017 and 55 million acres in 2019, with a total estimated market opportunity of 80 million acres.

However, it should be noted that the U.S. Environmental Protection Agency has not approved the in-crop use of dicamba for the Xtend trait, which means farmers planting the soybean seeds aren't allowed to take advantage of that specific trait in the stack at the moment. Of course, farmers have used dicamba on the crops anyway, which has many questioning whether or not Monsanto should have sold seeds with an unapproved trait to begin with. (It probably shouldn't have.)

Similar to the Roundup technology platform, Monsanto will sell both proprietary seeds and herbicides to offer a complete set of solutions for farmers. The company's Roundup Xtend VaporGrip and Xtendimax VaporGrip herbicides are formulations of both glyphosate and dicamba, which will be sourced from external dicamba supplies until the new manufacturing facility begins operations. At that point management expects the Roundup Ready Xtend crop system to deliver at least 30% returns. The dicamba factory will supply up to 35% of total industry demand. While the new herbicides are designed to not travel by wind -- so as not to affect neighboring farms -- they are also awaiting EPA approval. 

Admittedly, the nomenclature can be difficult to follow, but the table below shows Monsanto's marketing team does have it organized:

Data source: Monsanto. 

Monsanto has also been active in licensing the Xtend trait to industry peers. A much-heated legal dispute with DuPont ended in 2013 with the company agreeing to pay Monsanto at least $1.75 billion through 2017 to license certain technologies including Xtend. DuPont will then pay royalties on sales of seeds containing the Xtend trait beginning in 2018. And, as mentioned in the introduction, DuPont has also agreed to purchase some of the output from Monsanto's future dicamba manufacturing facility for its own proprietary herbicide mixture branded DuPont FeXapan herbicide plus VaporGrip Technology.

What does it mean for investors?

While the Roundup crop system catapulted Monsanto to the forefront of the industry, the Roundup Ready 2 Xtend crop system can allow it maintain both its leadership position and growth. That is even more likely after a competing dicamba trait and herbicide system developed by Dow Chemical was nearly universally shunned by industry peers in favor of Monsanto's platform. It later ran into regulatory issues that will further delay its commercialization and use -- giving Monsanto even more time to capture market share for dicamba crop systems and marking the equivalent of a knockout punch for Dow.

A combination of farmer needs to respond to glyphosate tolerant weeds and advances in agricultural biotechnology support the need for Roundup Ready 2 Xtend crops. Monsanto's R&D labs and its new dicamba manufacturing facility have made it possible. Despite the controversy surrounding the launch of new seeds, the platform should create tremendous value for farmers and the company.