Why This Company Could Solve World Hunger
Shares of multinational agricultural biotechnology corporation Monsanto Company (NYSE: MON) are down 8% this month, after the company announced it will drop all of its European Union requests for the approval of new genetically modified crops. Meanwhile, in the U.S., the federal government has started to search inside Monsanto's business looking for antitrust violations.
These factors may be playing against Monsanto's shares, causing market sentiment to be negative. But as a global leader in agricultural biotechnology and with an increasingly important genetically modified (GM) seeds business unit (more than 170 million hectares of land are said to be under genetically modified crops now), will Monsanto be able to recover from its current misfortunes and expand its business to the rest of the world?
A great story behind the stock
For the past 10 years, Monsanto managed to grow its revenue base moderately. This could change if Monsanto manages to get its GM crops approved by most legislations in the world.
Considering how controversial GM crops remain in the mind of most citizens and politicians, is this possible? Well, maybe not in the short run, but the long run shows some trends that could bring some hope to the company.
According to a recent study , if the world is to grow enough food for the projected global population in 2050 (9.6 billion), agricultural productivity would need to rise by at least 60%. In real life, corn, rice, wheat and soybeans are increasing 0.9%-1.6% every year. This is just too low to meet the requirements for 2050. These crops would increase 38-67% by 2050, rather than the required 60-110%.
Source: Monsanto Investor Relations, Presentation slides
Furthermore, in some countries (Eastern Europe), crop yields are actually decreasing. At the same time, the cost of food keeps rising globally. And looking at the global market for corn, Monsanto argues that demand growth has by far outpaced supply.
Who is to solve this problem?
Monsanto's yield-improving technologies and GM seeds may be the answer. It owns a massive germplasm bank across six continents, and would be more than happy to supply GM seeds to most farmers in the world, if that becomes legally possible. It already has a strong presence in the Americas region, with more than 150 million hybrid planted acres so far. According to Morningstar, roughly 90% of the soybeans and 80% of the corn grown in the U.S. contain a Monsanto trait.
If the remaining world regions follow the pattern shown in America, Monsanto's cash flow could see a massive increase in volume. And the urgent need for yield improvement could force negative consumer sentiment toward GM crops to change.
Fundamentals remain strong. In the third quarter of 2013, sales rose 0.7% from a year earlier, to $4.25 billion. However, Monsanto could not beat the street consensus. Soybean sales declined 5.7%, but corn seeds sales (one third of total revenue) increased 3%.
Falling commodity prices in the U.S. and a legal dispute regarding royalties on soybeans in Brazil played against Monsanto's revenue. However, because these are all external factors, the company believes its core competence remains intact, and therefore reaffirmed its earnings guidance in the range of $4.50 to $4.58 a share for this fiscal year.
Clean balance sheet, high dividend and active repurchases
Monsanto has $2.1 billion in long-term debt. This is huge but below the $3.1 billion of cash and equivalents that Monsanto has accumulated so far. Therefore, the balance sheet remains solid.
In terms of return of value to shareholders, the company will deliver a quarterly dividend of $0.375 cents per share (roughly 1.5% annual yield). And it just authorized a new $2 billion 3-years buyback program.
High market valuation
One clear downside to getting long Monsanto is that the current market valuation may not represent an interesting entry point for investors. Using Oldschoolvalue financial spreadsheets, I run a discounted cash flow model, assuming a 4% terminal growth rate and a 9% discounted cash flow, taking into consideration the strength of Monsanto's balance sheet. The result? In order for Monsanto to justify its current stock price, it would need to grow at an average rate of 12% for the next 10 years.
Now, the average of the 10 years and 5 years free cash flow growth rates is 5.2%, well below 12%. So, if you assume that Monsanto will keep a 5.2% growth rate for the next 10 years, the company is clearly overvalued.
But, on the other hand, if you assume that growth for the next 10 years will be similar to the latest year-over-year sales growth rates (13% in 2011 and 14% in 2012), the fair price of Monsanto can rise up to $103 per share.
At first glance, it may be over optimistic to assume such growth rates will be sustainable for 10 years, but if Monsanto manages to increase the scope of GM crops and to overcome the increasing regulatory hurdles surrounding the usage of its products to meet global demand of grain, such growth rates could actually happen.
Increasing competition in the GM seeds market could hurt margins
Finally, a word of caution. A wider global acceptance of GM crops would also benefit Monsanto's main competitors Syngenta (NYSE: SYT) and E I Du Pont De Nemours And Co (NYSE: DD) .
Syngenta is strong in crop protection products and corn seeds. Although the latest quarter showed revenue increased only 2%, the company remains ambitious in its long-term horizon, and is planning to practically double its level of sales by 2020: a 10% CAGR for the next 7 years.
To achieve its plan, Syngenta will need to steal market share in emerging markets like Latin America, where Monsanto is well positioned. And although Syngenta's seeds are as competitive as Monsanto's DeKalb or DuPont's Pioneer, both giants won't make things easier for the Swiss company. Most likely, every player will see its margins hurt.
Dupont, on the other hand, is betting on Africa. The company just announced the acquisition of a majority stake in Pannar Seed , probably Africa's largest seed producer. This could be a great strategic move, if you consider that about 20% of the global area under maize cultivation is said to be in that continent, where the average yield is roughly a fifth of the equivalent in Europe.
Notice, though, that DuPont's soybean business depends on Monsanto, because it borrows Monsanto's technology in exchange of $802 million. In the future, Monsanto can increase the price of royalties to obtain better margins. This risk can't be ignored.
Final foolish thoughts
My overall rating is positive. Monsanto's fundamentals remain strong after the latest quarter. Plus, this stock has a great story behind.
The increasing global demand for crops and need for yield efficiency are facts. In the absence of better alternatives, consumers and politicians might start increasing their acceptance level to the usage of GM crops. This is the catalyst that Monsanto has been waiting for the past 2 decades.
Picture: corn by design suite