Seeds of Growth for Monsanto

By Julian Murdoch

We talk about ag futures and ETFs, we talk about investing in the fertilizer market, but there is another aspect to the supply chain in the agriculture market we haven't touched on lately - the seed business. Unlike, say, gold and oil, where simply buying one or two companies gets you huge exposure to the entire supply chain, with ags, the chain is a lot more disjointed.

Traditionally farmers would allow their crops to go to seed, and then collect and clean the seeds for planting in the spring - capitalizing on the circle of life. But because of the technological changes in seed strains (i.e., genetic modifications), that isn't an option - some GMO crops don't yield usable seeds, and of those that do, buyers aren't allowed to harvest those seeds and reuse them. It's patent protection, and right or wrong, this means that Monsanto has a built-in market each spring.

Monsanto is the largest seed company in the market, controlling large shares of the market in the U.S., Brazil and Argentina, as well as around the world. And while the second quarter traditionally is best at forecasting how the company will perform over the entire year (due to the majority of corn and soy seed sales occurring during those three months), the third quarter does supply good information on where the company is going - especially this quarter.

Roundup

First, the news the company focused on during its earnings call: The company that created the herbicide "Roundup," and subsequent "Roundup Ready" seed lines, has announced a restructuring of its Roundup business. Monsanto is putting all of its Roundup product lines into one group in response to "recent market activity" - said activity being declining sales. Roundup has lost market share as low-priced competitors have come on fast and furiously since the U.S. patent on the chemical formulation expired in 2000 - Roundup has become a kind of generic drug. Subsequently, the generic industrial price of the chemical itself (not an actual gallon of goo sold to a farmer) dropped from $10 a kilo last August to $3 a kilo currently, which the company is expecting to be the new norm.

By concentrating the product line into a single group, Monsanto hopes to contain costs and milk whatever profits it can to fund R&D elsewhere in the company, with a goal of $1 billion in profits by 2012. That's not a "stretch" goal in the traditional sense - it's half of what the company is expecting for 2009. This is just an attempt to stem the bleeding. Exactly what price/value/volume equation management will be aiming for is still being worked out, but the company probably will not be holding farmers to the same $20-a-gallon price that has been losing them so much market share."

Additionally, Monsanto is forecasting that by 2012, the profit from Roundup will only account for 15% of the company's gross profit, as it intends to concentrate on the seed business, down from a historical 30-40%. That's a big change from the emphasis on chemicals in the beginning of the company's history. They're not getting out of the business though - Carl Casale, EVP of Strategy and Operations expects that demand for Roundup will continue to grow - but the growth is really just in single digits in the coming years.

As far as earnings go, it was a case of good news/bad news - Monsanto beat analysts' expectations, but still booked an 11% drop in third-quarter sales to $3.16 billion, and a 7% decrease in gross profit to $1.83 billion. Cost savings resulted in an uptick of 2 percentage points in the gross margin. Diluted earnings per share dropped to $1.25 from $1.45 in Q3'2008 - a 14% decrease due to the huge drop in Roundup-related profits.

In other positive news, in the first nine months, gross profit from corn seed rose 21% compared with this time last year. Soybean seed looked even better, with a 32% increase. And in total, the seed revenues grew 17% in the third quarter.

All of this means that Monsanto is continuing on its journey away from chemical manufacturing and toward being more of a biotech company. CEO Hugh Grant said, "I don't see us having a broad chemical portfolio, that's not who we are." That exact comparison was made during the 3Q conference call when the panel put up a graph showing how Monsanto's R&D spending (about 10% of sales) looks similar to what you'd see in biotech.

But, as Gary Dvorchak reports on RealMoney:

"The case may not be totally persuasive -- biotechs have the potential to create new blockbusters, and Monsanto doesn't -- but the company may ultimately get multiple expansion simply on shedding the shadow of the old chemical business."

,

Even if Monsanto can't deliver a "blockbuster" the way a typical biotech firm might, it does have quite a bit in the development pipeline, with new products forecast to arrive roughly every year. Bug-resistant seeds, drought-resistant seeds, fungus-resistant seeds - are all examples of technology coming down the pipe; developments that Monsanto is planning to cash in on to double their 2007 gross profits by 2012. Of course, the shift from a stodgy chemical business to a go-for-broke biotech company implies a radical change in the risk and risk premium investors should expect from the company.

How that shows up in your portfolio - with the rise and fall of the stock - remains to be seen. At a P/E of 19, it's already priced like the rebel in its sector, especially compared with the really stodgy fertilizer companies like Mosaic (NYSE Arca: MOS) or Agrium (NYSE Arca: AGU). They can't poke their heads above a P/E of 10 on their best days.

If you prefer your investments in ETF form - remember, Monsanto is part of MOO - Market Vectors Agribusiness ETF [NYSE Arca: MOO], along with competitor Syngenta AG [NYSE: SYT] and a host of other agribusinesses. On Wednesday at 3 p.m., MOO was up 2.19%, while Monsanto had dropped 4.11%.

Comments

[greg weitzner:]

There is a huge future in genetically modified seeds and Monsanto is clearly at the forefrunt.

Jun 25 11:11 AM

[optionsgirl:]

Check out SEED (Chinese) and Landec Corp (can't remember the ticker).

Jun 25 11:48 AM

[Mad Hedge F...:]

It is possible that genetic engineering, sustainable farming, and smart irrigation could lead to a second green revolution, but the burden is on scientists to deliver. The net net of all of this is that food prices are going up, a lot. Entertain core long positions in corn, wheat, and soybeans on the next dip, as well as the second derivative plays like Agrium (TO), Potash (POT) and Monsanto (MON). You might also look at DB Commodities Tracking Index Fund (DBC). These will all surpass last year’s stratospheric highs at some point.

Jun 25 01:11 PM

[sticktoitiv...:]

Monsanto needs to team up with the fed and work on those green shoots.

I think drought-resistant seeds are going to be big, many places can't sustain agriculture simply from a lack of water. It opens up new markets.

Jun 25 01:30 PM

[Griller:]

There is indeed a great future for genetically engineered products, but Monsanto will be at the forefront for another three to five years at most, because others will be able to engineer the same products and sell them much cheaper. I predict that a Chinese firm with lower costs and government protection will run Monsanto right out of business. Who says "buyers aren't allowed to harvest those seeds and reuse them."

Jun 25 01:44 PM

[sticktoitiv...:]

"but Monsanto will be at the forefront for another three to five years at most"

Most countries regulate witch seeds are approved to grow and with aren't, that often takes years.

"Who says "buyers aren't allowed to harvest those seeds and reuse them.""

If some countries want to steal the key to the patent office, turn about is fair play, everything is a commodity and no one wins, even china.

Jun 25 02:06 PM

[Griller:]

Who says "buyers aren't allowed to harvest those seeds and reuse them."

Who wins? Did Bill Gates? Has any major Hollywood studio, or musician? Will the US ever again be able to dictate terms to China, or try to, as Bill did?

Jun 25 07:46 PM

[Griller:]

Who says "buyers aren't allowed to harvest those seeds and reuse them."
Did Bill Gates win when he tried to enforce his ownership? Has any Hollywood studio/actor/musician? DVDs are a buck in Shenzhen. I think the Chinese won and will continue to.

Jun 25 07:48 PM

[mkreisel:]

When countries are facing famines, they are not going to respect intellectual property rights.

Jun 25 08:09 PM

[E Nuff Sed:]

Interesting comparison of Monsanto with botechs. I remember Monsanto originally a chemical company had a drug division called Searle. Monsanto then acquired a swedish company called Pharmacia - combined it with Searle and spun the seed/chemical business off as "monsanto". Pharmacia itself was swallowed up by Pfizer.
As Monsanto keeps increasing its expertise in biotech - it could easily get into drug biotech and come a full circle.

Jun 25 10:38 PM

[Moon Kil Woong:]

SYT, MON, SEED etc are all worth a look at if you are interested in a growth agriculture sector. I would not lop them into the same level as Biotech though. Biotechs business model and channel distribution are totally different and biotechs themselves need mot make money to get valuation. That's the duty of their partners or pharmaceutical acquirers. These companies do need to make money. If they don't make money there is something seriously wrong.

Jun 26 01:25 AM

[donzelion:]

I like Monsanto's model quite a bit: farmers have an option of natural seeds or modified seeds, as they have for millennia, but if they pay extra, they get extra benefit (and when farm sizes and water rights limit capacity, extra yield any way you get it can be worth it).

However, I'm confident that many players can find niches in agriculture, and I'm confident that the basic risks of boom/busts won't change. Hence, I'll stick with ETFs: MOO and DBA are the new classic plays, but PAGG is a promising MOO alternative (it's very narrowly traded and newer, but I like the slightly broader international diversification).

Jun 26 05:42 AM

[Eye Forget:]

I admire MON and SYT but they are fighting an uphill battle with little chance of winning in developing countries. Rightly so, hungry children will come first.

In developed countries they face the EU "natural foods" lobby and protected markets all over the place that allow farmers to plow postage stamp size fields with oxen and sell to local populations unhampered from competition.

The end result is US farmers will have more costs than the competition, cry louder, hire more lobbyists and force the US consumer to pay for a Hollywood directed mentality towards absurd intellectual property rights legislation.

I've traded in and out of both companies. They tend to be good short term plays but I have my doubts they will flourish in the long-run. Sort of like picking up free dvds (that replenish themselves) in the privacy of one's own fields. Even if the seed use spreads, the income steams won't.

Jun 26 11:51 AM

[Daryan:]

Nothing fundamental, but buying MON here out of a Head and Shoulders Top, confirmed a couple days ago with a downside target of $65 is pretty follish if you ask me...but then again, all these green shoots are sure to sprout some roots, right!

Jun 26 02:35 PM

[Jade Queen:]

Vandana Shiva's comment on the Gates Foundation gift to Monsanto of $47 million, for "inventing" seeds adapted to climate change: "Seeds bred in labs are adapted to labs." Interest is great in open-pollinated seeds adapted to local conditions. What's more, organic farmers have begun to recover for damages caused by drift from neighbors' practices. The new movie, Food, Inc., gives another interesting take, in addition to the French movie, The World According to Monsanto. There will come a point where staggering influence in D.C. just won't be enough. BreakTheMatrix has an interesting action alert out on the subject. Indian farmers are organizing to share local seeds, and clover is being used in China as a cover crop. I am foreseeing sea changes in this industry. The crusade against rBGH by Physicians for Social Responsibility, leading to the sale of that business, is just the beginning. Strategy has moved away from Congress and toward food companies, bombarding these companies with post cards from individuals. In my experience, the companies are more responsive to individual consumers than most Congresspersons are.

Not a long-term bet is an understatement.

Jun 26 07:26 PM