Monsanto: The Quintessential 'Growth' Stock

Monsanto Company [NYSE:MON] May 19, 2009 - $89.60
52-week range: $63.47 (Nov. 21, 2008) - $145.80 (Jun. 18, 2008)
Dividend = $0.265 quarterly = 1.18% current yield

Monsanto is the world's leading producer of seeds. The company's seeds and genomics division combines advanced breeding and biotechnology traits to produce high-value-added seeds for corn, soybeans, cotton, fruits, vegetables, and other crops. The agricultural productivity segment produces a number of herbicides, including Roundup [company profile from Morningstar].

MON (most recently) came public in October 2000 and has shown spectacular numbers ever since. Split-adjusted earnings rocketed from $0.34 to $3.39 from FY 2000 through FY 2008 (ended August 2008). The first half comparison for the current fiscal year is $3.14 versus $2.25. EPS from the first six months cannot be extrapolated to the full year due to predictable seasonal losses in Q4 each year.

Here are the per share numbers (from continuing operations) as reported by Value Line:

Zacks is looks for $4.65 and $5.22 in FY 2009 and 2010 making MON’s multiple about 19.3x this year’s and 17.2x FY 2010’s expectations. While not ‘cheap’ in an absolute sense, these shares are now at the second lowest valuation in this decade.

The balance sheet looks great. As of February 28th, Monsanto held over $2 billion in cash versus total debt of just over $1.8 billion. The rapidly growing dividend is well covered at less than a 23% payout ratio.

Morningstar is a fan of this company. They assign MON their highest (5-Star) overall rating and figure ‘Fair Value’ at $145 – a level actually touched during last spring’s commodities boom. Value Line thinks Monsanto can earn $7.50 /share by 2012 – 2014 and sees a 3 – 5 year target price range of $150 - $225.

Monsanto provides a 'dollar hedge' with its worldwide revenue streams and at least a modicum of recession resistance with its agricultural product line. They funnel about 10% of revenues directly into R&D to maintain their leadership position.

Here is my 20-month combination play for Monsanto that will provide a very nice total return, even if the shares just ‘mark time’ from now until January 2011.

If Monsanto shares go up just 40 cents or plus 0.5% by January 21, 2011:

The $90 call will be exercised.
You will sell your shares for $9,000.
The $90 put will expire worthless- a good thing for you as a seller.
You will likely have collected $185 in dividends.
You will have no further option obligations.

You will end up with no shares and $9,185 cash for your original outlay of $5,440.

That’s a net total profit of $3,745 / $5,440 = 68.8% achieved in just 20 months on shares which only needed to rise < 1%.

What’s the risk?

If Monsanto shares finish under $90 on January 21, 2011:

The $90 call will expire worthless.
The $90 put will be exercised.
You will be forced to buy another 100 shares and to lay
out an additional $9,000.
You will likely have collected $185 in dividends.
You will have no further option obligations.
You will end up with 200 MON shares.

What’s the break-even point on the whole trade?

On the first 100 shares it’s their $89.60 cost less the $17.50 /share call premium = $72.10 /share.

On the ‘put’ shares it’s the $90 strike price less the $17.70 /share put premium = $72.30.

Your break-even is thus $72.20 /share (excluding dividends).

Monsanto shares could drop by $17.40 or (-19.4%) without causing a loss on the trade.

This Monsanto combination offers 20-month upside of almost 70%, downside protection of more than 19% and beautiful fundamentals.

Now that’s “growth you can believe in.”

Some will criticize me for writing such conservative ‘at-the-money' options.Keep in mind, though, that outright buyers of Monsanto shares at today’s quote of $89.60 would need to see a final share price of over $150 to make the same percentage gain from trade inception.

Disclosure: Author is long MON shares and short MON options.

Comments

[Daniel Moser:]

Monstanto might be a fine company but your evaluation of your option trade is misrepresentative.

First of all you are analyzing returns from an "initial cash outlay" which is fundamentally flawed because the reality is you have to have 18K set aside for this trade or you will find yourself bankrupt should MOS trade below 90 at expiration obligating you to spend an additional 9K on buying the stock.

Secondly, your analysis didn't show any major moves in the stock price over the course of the next year and a half. So, here goes...

What if MOS is well above 90 at expiration? Lets take an extreme case...lets say MOS is at 150 at expiration in 2011. You will gain 6,000 in profit on the stock. You will lose 4250 = ((90-150)*100+1750)on the call you sold @ 90. You will gain 1770 on the put option that was sold. This sums up to a net profit of 3520. Now this might seem like a grand return on what you call your outlay...however when you properly account for how much capital you need to have to realistically put this trade on without the fear of going bankrupt...it is 3520/18000 or 19.6% return over the course of 1.5 years - or a 13.04% annualized return. Hardly a great return relative to a 66% total move in a stock (or 44.5% annualized).

What if you simply bought 18,000 worth of MOS and saw a similar move in the stock....you would earn 12,000 or the whole trade or the entire 66% return.

What about the other direction? What if the stock falls to 50? You would lose 4000 on the stock. You gain 1750 from the call you sold. And you would lose 2230 = ((50-90)*100+1770) from the put you sold @ 90. For a net loss of 4480 or a total loss of 24.9% (or annualized -16.59%).

If you are bullish on MOS, it would be far better to simply buy 9K or 18K worth of MOS and use a stop loss. Your option strategy is oriented for someone who doesn't think there is much upside potential in MOS over the next 1.5 years.

May 20 12:31 PM

[Paul Price:]

I write my puts against marginable equity that is already in my account in the form of paid-up shares of stock (that could include the long shares of MON or any other companies.)

In doing that I avoid the need for ANY additional cash outlay unless and until the put is actually exercised. If MON shares stay above $90, as I expect, then I will NEVER have to lay out the extra $9,000 cash.

That makes the described profit and percentage gain exactly correct on a cash-on-cash basis.

If you think Monsanto is going to $50 you shouldn't be doing this trade or buying the shares outright.

The best-case gain of 68.8% is, indeed, just as good as a move to $150 for the straight buyer of the shares.

May 20 01:01 PM

[Paul Price:]

One further note...

If MON should stay unchanged through expiration date...

The straight buyer would have made only the 1.2% dividend per year.

The combination player would have a nice gain.

$1,750 from the expired call.
$1,700 or so from the put after closing it out near expiration with the shares only $0.40 in the money.
Plus the same 1.2% annual dividends as the outright buyer.

An extra $3,450 goes a long way to making this a better trade.

If Monsanto dropped to $72.30 by expiration date:

The straight shareholder would be down $17.30 /share or minus $1,730 (ignoring diviends).

The combination writer would be even (not counting dividends).

Thus, the combination writer is better off if...

The shares go up to as much as $150.
The shares stay unchanged.
The shares drop moderately.

That covers all the most likely scenarios and is the reason I do what was described in my write-up.

May 20 01:10 PM

[Daniel Moser:]

First of all, it is a misrepresentation of return on capital at risk, because if the puts expire in the money, you do have to pay an additional 9K and if you don't have it you are screwed. Thus a better basis to measure return, in my opinion, is using the net obligation of 18K.

Secondly, In what world is 3520 total profit better than 6000 (for 100 shares)? And suppose you prescribe to my method of accounting for the return on this...in what world is 3520 total profit better than 12,000 (for holding 200 shares outright if MOS moves to 150)?

May 20 01:54 PM

[Robbo the Y...:]

Hi Paul,

New investor here, still in the learning phase of things and I've been following your recommended plays for a month or so now.

In the context of Dan's critique:

"First of all, it is a misrepresentation of return on capital at risk, because if the puts expire in the money, you do have to pay an additional 9K and if you don't have it you are screwed,"

and your typical sub-strike price language:

"If Monsanto shares finish under $90 on January 21, 2011:

The $90 call will expire worthless.
The $90 put will be exercised.
You will be forced to buy another 100 shares and to lay
out an additional $9,000.
You will likely have collected $185 in dividends.
You will have no further option obligations.
You will end up with 200 MON shares."

my question is this: Rather than buy another 100 shares under the above-described scenario, couldn't you just sell the shares you already purchased (at the outset of the play) on the exercise date and use the proceeds to pay for the bulk of the put obligation buy? That seems to me like a good alternative to ending up with 200 shares, as you suggest in the MON example, and it allows the investor to do this play without having another $9,000 available should the shares close below the put strike price, as Dan Moser suggests would be necessary? What am I missing here?

May 20 02:59 PM

[Paul Price:]

Robbo,

You can sell your shares at anytime you like (if your calls are closed-out, have expired or you're willing to go naked and have brokerage approval for that technique.

I just try to keep things simple in my write-ups to make it easy to understand the 'worst-case' scenario should it occur.

At expiration date if MON is below $90 you could sell all 200 shares and have a profit as long as the shares were above the break-even price of $72.20 /share.

May 20 03:40 PM

[socphd71:]

I agree that Monsanto is a theoretical good buy. This is based on the maxim that, THE MORE EVIL A COMPANY, THE BETTER IT IS AS AN INVESTMENT.

Here's one link, of many, to be found by Googling "Monsanto"

www.ethicalinvesting.c.../

I won't try to even list, let alone describe, Monsanto's evil practices. Others have done a much better job than I could.

Disclosure: Long MO (formerly Philip Morris). No position in Monsanto.

May 20 08:30 PM

[Paul Price:]

Better to own Phillip Morris that kills its customers every day?

May 20 08:43 PM

[magor:]

Selling a Put requires that it is "cash secured" meaning that $9000
is tied up so that if the stock drops below $90 money is available to
buy the stock. Consider selling a put with a low Delta to increase the probability of making a profit.

May 21 09:03 AM

[Paul Price:]

magor,

You only need to be 'cash secured' in retirement accounts like IRAs, Keoughs or 401Ks.

Normal, margin type accounts can use any marginable equity to write puts against.

May 21 09:07 AM

[magor:]

If you have $9000 available in your margin account, that amount is no longer available for trading. From actual experience


On May 21 09:07 AM Paul Price wrote:

> magor,
>
> You only need to be 'cash secured' in retirement accounts like IRAs,
> Keoughs or 401Ks.
>
> Normal, margin type accounts can use any marginable equity to write
> puts against.

May 21 10:57 AM

[socphd71:]

Thanks for your post, Paul. I try to practice what I preach. MO is an evil company, I agree. As you say, "Philip Morris kills ... every day."

Note that it took 30 years from the epidemiological evidence on cigarettes to the biological link. With genetic modification (GM), we don't even have the epidemiological evidence. MON, nonetheless, is engaged in a world class experiment. GM foods -- often called 'Frankenfoods' -- are almost unavoidable in the US, China, and many other countries. Most of Europe is still mostly GM-free. When the children who were conceived, while their parents were on GM foods, grow old, the evidence will start to come in.

Meantime, we have many suicides among Indian cotton farmers whose GM crops failed. Also, many Americans are now boycotting milk from cows given a GM hormone.

Buy MON; the most evil companies make more money than the least evil companies.

May 21 04:48 PM

[bassmaster17:]

Citi downgrade on a pre-holiday Friday, don't sell your shares to them, the opinion-motivation of a company that should be bankrupt has no credence.

May 22 01:41 PM

[Paul Price:]

No Need to Harvest Monsanto

MONDAY, JUNE 1, 2009
Barrons - FOLLOW UP

A return to topics discussed in earlier issues.

WHEN MONSANTO'S STOCK PLUNGED EARLY LAST WEEK from 87.50 to 79, it seemed like a rational retreat. The giant seed company had just lowered its guidance for the fiscal third quarter ending August to $1.15 a share from its earlier forecast of $1.61, warning it expected full-year earnings at the low end of its prior range of $4.40 to $4.50. The Friday close, at 82, left the shares trading at a prospective price-earnings multiple of 18.7.

On reflection, however, the stock-price drop looks like an overreaction to bad news, creating a buying opportunity. We have been longtime supporters of Monsanto ("Eat Up!," Dec. 6, 2004) based on the growing acceptance of genetically modified seed and the company's central role in the marketplace. We don't see any reason to back away based on last week's events.

UBS' Don Carson notes that, even with the revised numbers, Monsanto is growing at a 20% rate. He thinks the stock is headed above $115 /share within 12 months.

The company said two unique factors are responsible for the shortfall. Wet weather in the U.S. corn belt delayed the normal seasonal application of its top-selling weed killer, Roundup. That lack of demand in turn encouraged Chinese makers of generic competitors to undercut Roundup prices to move their own stocks. Both factors will have only limited impact since, when fields dry, Roundup sales and prices are likely to return to normal.

Otherwise, Monsanto has a healthy balance sheet and spins off bushels of cash that averaged near 25% of sales over the past five years -- much of it going to develop the vital genetically modified crop program. To harvest those gains, investors should hold on or possibly buy more.

May 31 05:55 AM

[User 56037:]

Would very much appreciate some shorter option strategies, say in the 4 month range.

Roz

May 31 09:42 AM

[don corpier:]

i hope every one of you ass holes lose your shirts with monsanto. this is the most evil co. on the face of the earth. they are responsible for many thousands of deaths in vietnam and many thousands of vietnam vets are still suffering today. they are a predatory monster that screws every farmer in the world. those that dont realize it now will soon discover the true nature of this co. they are going at full steam to try and control the food supply from seed to end product. many of their products are unsafe.

May 31 07:52 PM