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%.
