When management teams layout mid-term targets, investors expect them to hit those targets. That's a consideration that comes to mind with Corteva Agriscience (CTVA -0.74%) and its 2022 target. The market fretted over the issue this year, but the company seems on track -- the stock is up more than 25% this year. Here's the lowdown, and why Corteva is an attractive stock for investors.
Corteva's recent history
It's fair to say that Corteva's performance has over-promised and under-delivered in the past, with former CEO Jim Collins acknowledging dissatisfaction in the spring. There's little doubt that the company -- created out of the DowDuPont merger and subsequent breakup -- has world-class seed and crop protection assets, but the question is whether management is extracting total value from them.
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It's a question attracting the interest of activist hedge fund Starboard Value, which now has directors on Corteva's board. The crux of Starboard's position is that Corteva has an opportunity to expand its profit margin to the levels of its peers, but Collins wasn't the right person to lead the improvement. So presumably, Starboard would have been happy to hear the news of Collins' retirement in the summer.
Starboard points out that Corteva's adjusted earnings before interest, taxation, depreciation, and amortization (EBITDA) margin was flat in the 2017-2020 period, but had the potential to increase from 14.4% in 2018 to 17% in 2021 and then 22% in 2023.
In doing so, adjusted EBITDA would rise from $2 billion in 2019 to $2.6 billion in 2021 and then $3.7 billion in 2023, representing a 42% increase in the four years from 2019-2023.
Those figures are actually in line with Corteva's expectations entering 2021: Management had forecast $2.4 billion to $2.5 billion in adjusted EBITDA for 2021, and then $2.8 billion to $3.1 billion for 2022.
Why Corteva soared in 2021
The simple reason is that, despite significant cost increases in 2021, Corteva is on track. Having raised adjusted EBITDA guidance to $2.5 billion to $2.6 billion in the second quarter, investors were concerned that Corteva would have to reduce it in the third quarter following soaring input and logistics costs. However, management reaffirmed the guidance on the third-quarter earnings presentations, despite raising its estimate for full-year "market-driven headwinds" from $375 million to $475 million.
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CFO Dave Anderson believes the "supply chain challenges and cost inflation" will extend through 2022, with seed cost increases of $250 million to $350 million and cost headwinds of $150 million in crop protection. Nevertheless, management reiterated the adjusted 2022 EBITDA target of $2.8 billion to $3.1 billion. The 2021 guidance pleased investors, as did Anderson's assertion that seed pricing would "outpace these costs in 2022."
Thanks to price and volume increases and cost cuts, management expects margin expansion in 2021 and 2022. The company is delivering on the potential that encouraged Starboard and others to invest in the company.
Do the near-term targets matter?
The 2022 guidance matters in the sense that investors frame expectations around them, but it's worth noting that Corteva is also reporting progress on a critical strategic objective that will drive earnings for years to come. Specifically, Corteva has a margin growth opportunity via increasing sales of products under its patents, resulting in reduced royalty costs paid to other companies.
One such product is its Enlist seed and crop protection platform. For reference, the seeds are resistant to crop protection (herbicides), which are applied both to control weeds and improve yield.
During the earnings call, VP Rajan Gajaria discussed the adoption of Enlist in the U.S., saying, " the overall adoption is going to be higher than what we had said in 2021. As you know, we had expected about 30%, and we grew to more than 35%."
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He also noted that in terms of Corteva's germplasm (seeds), "we've got a robust pipeline of new products coming through. Most of them are going to start hitting in '23, '24, but we are going to start making an impact in 2022." As such, it's reasonable to expect a positive contribution to margin coming from a relative reduction in royalty payments.
Looking ahead
Hitting the midpoint of the 2022 adjusted EBITDA target would put Corteva on an enterprise value to EBITDA multiple of less than 11. That's a reasonable multiple for a company that's had to contend with substantive cost increases. In addition, Corteva's margin expansion opportunity promises to translate mid-single-digit revenue increases into double-digit earnings growth. Meanwhile, Coteva is making good progress on its strategic objectives.
All told, the stock remains attractive for investors.
