Agriculture is a major slice of the U.S. economy, but it is hard for investors to buy into farms. One way to invest in ag is through the companies that supply farmers.
Corteva (NYSE:CTVA) is one such option. Created out of a chemical megamerger late last decade, the company is emerging as one of the most important vendors of seeds and chemicals to the global farm business.
In this video from Motley Fool Live, recorded on Jan. 28, Industry Focus host Nick Sciple and Motley Fool contributor Lou Whiteman provide an overview of Corteva and discuss both the merits of the business and some recent criticisms of the company and its management team.
Nick Sciple: You talk about genetically modified seeds, maybe some herbicides, pesticides, and stuff, that transitions us into this first company I wanted to talk about it with you today. That's Corteva, ticker C-T-V-A. It's a company that hasn't really been on the public markets very long. Came out of the Dow-DuPont spin-off in 2019, that would've been the last time we talked about it on the podcast. Can you tell us about what Corteva does?
Lou Whiteman: Most of it is the old Dow Agrosciences businesses. As people may recall, the Dow-DuPont came together with the plan to shuffle the assets around and create three more-focused companies. This is the combined, with scale, agriculture business of those two chemical giants. The operations are pretty much split between seeds and crop protection, which they do a lot of these modified seeds, specialized seeds. Then the other side of it is not Roundup, they don't own that, but a range of fertilizers and more importantly, herbicides and other products. We can get into it in depth, but there's a lot of synergies here, because increasingly, we are moving toward crops that resist certain herbicides, which makes it easier to get rid of weeds. It's a business that has a lot of potential, there's all sorts of stories about it. If you're a soybean farmer and you plant these herbicide-resistant soybeans, and then you spray the herbicide, your next-door neighbor darn well better have that too or they're going to lose their crop. There's almost a perverse way that once a product gets popular, it stays popular and grows. We're in the early days, but that's what Corteva is going for with soybeans and a lot of other products.
Sciple: These two sides of the business rhyme together. They will develop some type of, whether it's pesticide or an herbicide, or what have you. Then they'll also develop a proprietary seed that is resistant to those pesticides or herbicides. One thing you're going to talk about the business, historically Monsanto has been so dominant in the industry that Corteva is actually paying significant amounts of royalties to Monsanto for using some of their trades. But there are some opportunities for Corteva, and you talked about the investment case here, as they move more and more of their products to their own proprietary seed trades and things like that. They can take out some of those licensing fees they're paying to Monsanto, it really gives them an opportunity. You can project out over the next several years where they can expand their margins in a meaningful way.
Whiteman: The idea of it, if you have a better mousetrap, it will sell. Your customers are very reliant on getting the best yield they have. That has been the business model for these chemical companies, that's why they are so involved in ag. We have a company at scale, they're one of a few, but are really trying to do this in a coordinated way at scale where they can really dominate a market.
Sciple: Just to throw some numbers out there. In 2018, about 18% of their portfolio was patented to their own existing in-house patents. They expect to have 34% of that by 2023, so really expanding the patent portion of their portfolio. Also introducing some new herbicide, pesticide products to the market. Hopefully, it can take some share from Monsanto, some of these other companies. I pulled a stat, two-thirds of Corteva's pioneer soybean seed use Monsanto's chemical traits now. A significant portion of their seeds that are subject to some of these licensing fees. But overtime, it can bring those down and hopefully expand margins as well as when they're launching some of these new products. The other thing to think about as well is, since the spin, they've been trying to get some of their costs under control, reducing headcount, those sorts of things. Can you tell us some about their efforts there, Lou?
Whiteman: They've reduced their manufacturing footprint pretty substantially, I think from 29 to 20 facilities since 2017. Headcount is down 25%. Again, this is what you'd expect from a merger. There's a lot of efficiency to be rung out here. Frankly, they've done a decent job of it. I don't think they would say, we're going to get into in a second about the activists, but they're the first to say that the job isn't over. But this is an early days company that they're still trying to put together the pieces they have and develop it out.
Sciple: We talked about that margin expansion opportunity. If you look at their adjusted EBITDA margin, about half of their competitors, Bayer, Monsanto, have given about 26.9% FMC, and other competitors about 28% compared to about 14% for Corteva. We talked about this opportunity to expand margins as they introduce new products and get less reliant on some other licensed trades. However, for some investors, not happening fast enough, in particular, Starboard Value. (NASDAQ:SVAC)
Whiteman: Starboard is a very well-known activist fund. We started getting hints back in November that they were going to get involved, and they have now nominated eight directors to the board for the 12 places and they are seeking to oust CEO Jim Collins due to what they call mediocre performance. We should note that, since this company went off on its own, June 2019, the stock is up 32%. That's basically in line with the S&P 500 and it's a lot better than either the other two, its sibling companies that came out of Dow-DuPont. DuPont is up about maybe 19% and Dow less than that, about 10%. It's not that the company has underperformed, but there is, as you say, the margins aren't what they want. Collins, the CEO, in response to Starboard said, "Probably the only question in the whole discussion is our view of the timing of the improvement." They were first to say, there's an improvement. It's going to be interesting, as far as an investor, looking at the stock to see who's in-charge in the next few months and whether or not there is an overhaul in the strategy which could be good, could be not so good.
Sciple: It'll be interesting because the management has laid out, like we talked about earlier, a path to where you can see margin expanding over time, and given the nature of the business, once you get in with these farmers, this is your core business. You have to grow these crops. Once you're in with these folks, it's going to be very difficult to dislodge them. There's clearly an opportunity there, it's going to be interesting to see with activists coming in, whether that is something that accelerates the pace of this transition or whether this is a distraction that gets in place of their execution. We'll see. I will say that Starboard historically has been a great allocator of capital. When they identify an opportunity, there tends to be real value there.