Agricultural productivity giant Monsanto (NYSE:MON) has faced a slightly higher wall of worry here of late. Calendar 2013 was an operationally strong year for the company and one that largely put to rest questions of the company's ability to recapture momentum from DuPont (NYSE:DD). For this quarter, though, there were worries that poor weather, difficult comps, and lower plantings were going to stall out the company's growth.
Analysts needn't have worried, as Monsanto once again delivered a better than expected quarter. With significant near-term opportunities in both corn and soybeans and longer-term opportunities in biologicals/microbials and precision agriculture, there are both growth and value catalysts to keep this stock moving.
Under-promise, over-deliver, rinse, and repeat
Monsanto doesn't always deliver beat-and-raise quarters, but the company has established a pretty solid reputation for under-promising and over-delivering. Perhaps even more encouraging in regard to the fiscal second quarter was that the company is no longer relying on surprising strength in its productivity business (Roundup herbicide) to patch over disappointments in the seed and genomics business.
Revenue rose almost 7% this quarter, good for a very modest beat against the sell-side average. Seed and genomics revenue rose 7%, with exceptional strength in soybeans (up 21%) offsetting a weaker result in corn (up 4%). Even so, given lower expected plantings for corn this year, that was a respectable result. Ag productivity sales were up 5% for the quarter.
Margins were stronger across all of the company's key businesses. Overall gross margin rose three points, good for a three-point beat against expectations. Seed GM improved more than two points (corn was up 250bp, with soy up 740bp), while ag productivity gross margin improved almost five and a half points. Adjusted operating income rose more than 14% this quarter (about 2% better than expected), with seed profits up almost 12%.
Big near-term opportunities in soy and corn
Monsanto has done a good job of repairing its reputation and relationship with farmers, and the result has been improved North American market share in both corn and soybeans. Monsanto and DuPont are back to more or less parity in corn (around 37% share each), with Syngenta (NYSE:SYT) and Dow Chemicals far behind in the single digits. DuPont is still stronger in soy (over 33% share versus close to 29% share for Monsanto), but Monsanto has been narrowing the gap in recent years.
As Monsanto looks to leverage its recent pipeline advances, there are reasons to believe the company could gain even more share in the U.S. and Latin America. Monsanto's Intacta soybean has shown a 4 bu/acre advantage over first-gen seeds and could unlock an incremental $1 billion in revenue in Brazil and Argentina. In the U.S., RR2 Xtend will be the company's first U.S. soy stack and not only could the company capture incremental acreage with this product, it could double its share of value and lead to another $1 billion in incremental sales. Better still, with DuPont now making meaningful license payments to Monsanto, Monsanto wins both ways.
With corn, the key product is a new and improved drought-tolerant corn variety. Monsanto beat DuPont and Syngenta to market with an improved variety and this product could help Monsanto gain some share in regions where it hasn't historically been as competitive.
Longer term, there are multiple major projects
Looking past 2015, Monsanto has several high-profile, high-potential incremental opportunities. Precision agriculture has shown the potential of improving yields by five to 10 bu/acre already and further refinements could improve both the yield advantages and the cost savings. DuPont and equipment companies like Deere have meaningful presences in this emerging opportunity, so Monsanto will have to share, and it is going to take years for the market to develop, but this could become a multibillion-dollar market opportunity.
Monsanto is also expanding its efforts outside of its traditional focus on transgenic seed varieties. The company is developing biological and microbial pesticides and herbicides, and is also using its genomics knowledge to develop designer organic fruits and vegetables that offer improved taste and shelf life but are still completely organic-compliant.
Last and not least is market expansion. Markets like Eastern Europe, South Africa, India, and China are still under-penetrated in terms of advanced seed varieties, and readers may be surprised to read that China is among the largest corn-growing countries in the world, growing almost 80% as much as the U.S. (around 70 million acres versus over 90 million acres). Syngenta does already have a meaningful presence in some of these markets, but the company is not as strong in the core corn and soybean markets that Monsanto intends to target.
The bottom line
Given Monsanto's under-leveraged balance sheet and the vagaries of the ag productivity business, I expect more calls for Monsanto to get more active on the business/financial engineering side. Frankly, I think spinning off the chemicals business now would do more harm than good – Roundup generates a lot of cash flow and creates a platform that the company can use to launch biological pesticides and herbicides in the future.
Betweeen Monsanto's traditional GM seed trait business, its Roundup glycophosphate business, and emerging opportunities in precision agriculture, non-GM crops, and biologicals/microbials, I look for the company to grow revenue at a "mid-high" single-digit rate of around 7% to 8%. I also look for the company to increasingly leverage past investments in R&D and distribution to move FCF margins into the high teens and into the 20%'s, supporting low-to-mid teens FCF growth. Discounted back, I come up with a fair value close to $125.
With a fair value of $125 using a required rate of return of 9%, I believe Monsanto can produce double-digit annual total returns for the next few years, making this still a stock very much worth consideration.