One line in Monsanto's (NYSE: MON) earnings report tells the whole story: Gross profit margins in its third fiscal quarter plummeted from 58% last year to 47% this year.
Welcome to the wonderful world of generics.
Gross profit on the company's Roundup business was actually negative this quarter. That's right, the company had to pay $189 million for the privilege of selling the herbicide. Some of that cost came from a restructuring charge as the company repositioned Roundup to compete with low-priced generics, but it's going to have to get a better read on farmers' needs if it's going to continue in the now low-margin business.
Management hopes the restructuring will help bring everything into an equilibrium, but without the ability to control the competition, I'm not sure how much Monsanto will be able to control the oversupply/undersupply cycle. Despite the efforts of Canpotex (the Canadian potash alliance), fertilizer producers have the same problem, with Mosaic (NYSE: MOS), PotashCorp (NYSE: POT), Agrium (NYSE: AGU), and the like recently experiencing their own feast or famine cycles.
Monsanto's seed trait business is more stable, but it didn't help gross margins as much as it could. A restructuring charge and added costs from launching new products caused gross margins for those products to slip as well. The good news is seed sales were still up 5%. Even if the company wasn't able to capture all the added revenue as profit, at least it's competing well against offerings from DuPont (NYSE: DD), Dow Chemical (NYSE: DOW), and Syngenta (NYSE: SYT). Margins should get a bump back up once the launch is over.
Shares slipped more than 1% yesterday, although they were down considerably more earlier in the day. It's tough to blame the quarterly results for the share decline since the dismal performance was expected. The company slashed guidance in May and actually beat the lowered range by $0.01.
Instead, I think the decline comes from investors' uncertainty about the future. Management isn't sure if the company will stay profitable or swing to a loss in its last fiscal quarter of 2010. More importantly, how much can we trust management's expectation of mid-teens growth in earnings once the generic-Roundup dust settles?
Buying shares in the midst of a transition could be very profitable, but cautious investors will want to wait until the company proves itself before investing.
