Monsanto: Temporary Weakness Presents Option Opportunity

Monsanto (MON) is the world's leading producer of seeds. The company's seed and genomics division combines advanced breeding and biotechnology traits to produce value-added seeds for corn, soybeans, cotton, fruits and vegetables, accounting for about 56% of 2008 revenues. The agricultural productivity segment [around 44% of 2008 sales] produces a number of herbicides, including Roundup. Monsanto plows about 10% of its revenues into R&D keeping them at the vanguard of their industry in terms of innovative products.

Fiscal year 2009 (ended August 31) showed all-time record EPS of $4.41 on continuing operations up from $3.39 in FY 2008. Generic competition for their flagship Roundup herbicide and general economic weakness has hurt the profit picture making the current FY’s estimate just $3.24 /share. Zacks expects a rebound to $4.71 in FY 2011.

This is a classic opportunity to enter a world class company at a depressed price due to temporary earnings weakness. MON shares have dropped almost 49% from their 2008 high of $145.80 to just $74.90 right now.

Monsanto is financially strong. Value Line rates them as having an ‘A’ financial strength and Standard & Poors gives them an ‘A+’ credit rating. Total interest coverage is about 25x. The dividend has been increased in six of the past nine years and is well covered at about 24% of last fiscal year’s EPS.

Here are Monsanto’s per share numbers from continuing operations as reported by Value Line:

FY	Sales	C/F	EPS	Div.	B/V	Avg. P/E
2002	8.94	1.48	0.60	0.24	9.91	19.4x
2003	9.40	1.50	0.64	0.24	9.81	14.3x
2004	10.65	1.73	0.81	0.28	10.26	19.5x
2005	12.32	2.06	1.05	0.34	10.98	26.0x
2006	13.52	2.28	1.31	0.34	12.01	30.0x
2007	15.69	2.85	1.98	0.55	13.75	28.0x
2008	20.72	4.50	3.39	0.83	17.09	32.3x

As noted earlier, FY 2009 came in at $4.41 (excluding restructuring charges).

With lower year-over-year comparisons likely over the next 12 months there is no near-term catalyst to move these shares. At the current quote, though, the downside seems limited. The actual panic lows hit in late 2008 and early 2009 were $63.47 and $69.60 respectively.

Here’s how I’m playing Monsanto with the share price at $74.90. I’m a writer (seller) of an assortment of the LEAP puts listed below.

January 2012 Exp.	Premium /share	Net Break-Even	Margin of Safety
$60 Puts	$9.10	$50.90	$24/sh. - 32.0%
$70 Puts	$13.80	$56.20	$18.70/sh. – 24.9%
$80 Puts	$19.40	$60.60	$14.30/sh. – 19.1%
$90 Puts	$26.00	$64.00	$10.90/sh. – 14.5%

If Monsanto commands about a 19 multiple by late 2011 when earnings are expected to be approaching $4.71 /share, the shares should be trading close to $90 by then. That suggests a high probability that all the above puts will either expire worthless or be trading at premiums that would allow for profitable close outs.

If I am ‘put’ prior to expiration it will be at prices 14.5% - 32% below today’s level, and I’d be comfortable owning the shares at those net prices. In fact, if those prices were available right now I’d be an immediate buyer.

Margin requirements may vary depending on your brokerage company but SEC regulations only require about 20% of the strike price to be held as collateral on a maintenance basis (subject to mark-to-market rules).

Why write for 2012?

• · Plenty of time for an earnings rebound.
• · High absolute option premiums due to the length of the contracts.
• · Low break-even points (due to the high option premiums received).
• · Nice margins of safety from the current $74.90 price.
• · Potential for tax deferment of gains until April 2013 (when you’ll file your 2010 Schedule D).

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

Comments

[Anthony B]

YES! I love your style Paul.

2009 Oct 08 04:33 PM

[Anthony B]

I think I might write one of the above strikes, but for 2011. Only about 20% extra on the premium for 2012. 2011 would still get be qualified as a long-term gain, hence still get the 15% tax bracket advantage.

2009 Oct 08 04:37 PM

[Paul Price]

NOTE: The last reason for writing for 2012 should read ...

Potential for tax deferment of gains until April 2013 (when you’ll file your 2012 Schedule D).

Not your 2010 Schedule D.

2009 Oct 08 05:34 PM

[Gravity404]

Paul, I too like this play.
What about the anti trust review by the DOJ?

2009 Oct 09 02:34 PM

[Paul Price]

Sowing the Seeds of Recovery

By KOPIN TAN - Barrons Nov. 28, 2009

Monsanto's having a dry spell, but it's sowing the seeds of future growth.

PLANTING SEEDS IS AN ACT OF FAITH, an investment in a future you can't yet see. That's something Monsanto shareholders need to keep in mind.

The agricultural giant is weathering an uncharacteristic dry spell: The 2009 stock-market rally that has lifted everything seems to have shortchanged agriculture, and falling grain prices limit farmers' willingness to pay up for crop seeds. At the same time, Monsanto's profits from selling herbicides have plummeted, while spending is increasing as the company prepares to launch two crucial new batches of genetically modified corn and soybeans.

T. Rowe Price New America Growth Fund (PRWAX), a major Monsanto shareholder. "The world is not blessed with an unlimited supply of water and arable land, and so farmers need better seed technology to improve crop yield." And unlike fertilizer, the market for genetically tweaked seeds still is largely underpenetrated outside the U.S.

China, for instance, has 22% of the world's population but just 7% of its arable land and 8% of its water. China already has to feed 12.5 people per hectare of arable land, compared with just 1.7 in the U.S., and it is rapidly losing farmland to industrialization.

Morgan Stanley's Andrews figures Monsanto's seed business will grow at an 18% pace in the next three years, with new products, increased pricing and a growing market share.

The Bottom Line

Monsanto shares are worth a bite. Although the company faces several near-term obstacles, especially in herbicides, its long-term prospects are very bright.

One big concern is that Monsanto has failed to gain U.S. market share in corn and soy while rival DuPont's (DD) Pioneer seed business did. But field trials show Monsanto's top three hybrids producing a higher yield of 10.6 bushels per acre compared with Pioneer's. That edge could help Monsanto in the future. Monsanto is expected to earn $4.40 a share in 2011 after a disappointing $3.29 in 2010. That's a future worth investing in.

2009 Nov 28 09:51 AM

[tripleblack]

I consider Monsanto's problems with the DOJ to be more than just a formality. The politicis involved are byzantine. This could come to a head in 2010.

2009 Nov 28 10:45 AM