After reaching a 52-week high of $11 in March, shares of S&W Seed Co. (SANW) are selling for just over $7 per share for the third time this year. To be honest at the open, this is a risky investment in a promising company in a very important industry. Analyst opinions range from buyto sell, and there are reasons for both extremes which is the focus of this article.
S&W is an agricultural company which has grown rapidly in a short period of time by purchasing additional farmland in Central and Imperial Valleys of California, by teaming with Forage Genetics and Monsanto to develop genetically modified organism GMO alfalfa seeds, and through the acquisitions of non-GMO seed companies Imperial Valley Seeds, Inc. (IVS) and Seed Genetics International Pty Ltd SGI in Australia in 2012 and 2013, respectively. The latter acquisition makes SANW the world's largest non-dormant alfalfa seed company (non-dormant means the seeds can grow year-round.) These non-GMO seeds are sold in the Western US, Mexico, South America, Africa, and the Middle East, parts of which prohibit the sale of GMO seeds. International sales represented 73% of revenue in fiscal 2013 (per the most recent 10-K, the first 30 pages of which contains a detailed description of the business.)
Growth. A $23,190,641, or 164%, increase in revenue for 2013 was primarily due to the acquisition of IVS on October 1, 2012 which contributed $13,032,220 of seed revenue as well as the acquisition of SGI which contributed $10,361,374. This was offset by a $202,953 or 1% decrease in revenue from S&W's existing ("organic") business. The following figure illustrates that these acquisitions have grown total assets faster than sales.
Gross profit margin for fiscal 2013 was squeezed by average cost per pound of seed sold in S&W's organic business, which increased approximately 31% from the prior year.
Economic moat. As long as people want to eat or keep livestock, there will be need for "forage" and alfalfa hay provides that forage. SANW's greatest expertise is in the breeding of year-round and salt-tolerant varieties which do well in hot dry climates or around the Mediterranean in the Middle East and Northern Africa. They also grow Roundup Ready® seeds which can be sold where GMO seeds are not prohibited. SANW grows its seeds outdoors whereas most competitors grow them in greenhouses. SANW considers its long history of developing these techniques to be a barrier to entry (again per the 10-K).
Risks. Most of SANW alfalfa seeds are purchased on contract from California famers, but direct farming began in 2011 and has expanded; this, however, carries with it the same risks of weather and pests that farmers face. Contamination of non-GMO with GMO plants could jeopardize sales in countries where sale of GMO seeds are prohibited. A single large customer in Saudi Arabia accounted for 67% and 24% of net sales in fiscal 2012 and 2013, respectively. Beginning on 114 acres in 2010, SANW tried to develop a market in the new and lucrative stevia business, but it was a bust with a $2.4M loss due to herbicide damage in 2013; the company is now focused on research in breeding and techniques of harvesting and milling of stevia.
Debt. In 2012 SANW sold shares for $5.50 and $5.85 raising a total of about $8.5M, then raised another $9.4M in January, 2013. The $11.8 million in cash on the SANW balance sheet for fiscal 2013 was due to a total of $24.5M of financing activities. As of the end of fiscal 2013 (June) SANW carried long-term debt of $4.6M. The debt-to-equity ratio is about 9%.
Financial Results. SANW was incorporated in 2009 with an IPO in 2010, had a net loss of $0.8M in 2011, and income of $0.375 in 2012; for 2013 the net loss was $2.5 million. This was due to SG&A expense of $5.7M, which was an 108% increase over 2012, primarily due to an increase in non-cash stock-based compensation of $1.1M and transaction and other costs associated with the IVS and SGI acquisitions. Most of its taxes (35% rate) were deferred. For the following figure, I summed SG&A over 5 years (2009-2013), and then used the average value to compute Net Operating Profit After Tax (NOPAT) for each of those years. Invested capital (IC) and market value added to that capital (MVA) were computed with all cash on the balance sheet counted as invested capital since SG&A and cost of goods are so high. The results suggest that as of the end of June 2013, the market has placed a high premium on the chances of S&W's future success; in other words, the stock market has added a great deal to balance sheet capital, particularly in relation to the size of SANW's NOPAT.
The sizable liabilities on the balance sheet have dampened the rise in net current asset value while the market cap has grown as shown in the next figure.
Summary. S&W Seed Co. is one of my favorite companies because of what it does and because its management is so ambitious. I bought SANW because I wanted agriculture with growth. SANW may be unique among publicly traded agricultural companies in terms of size and expertise, so an industry comparison is difficult. S&P Capital IQ lists 55 companies in the Food Products industry sorted by market cap: SANW is in the 50% percentile for market cap, is #3 in terms of revenue growth but #38 for total revenue, and near the bottom of the 2013 list for return on capital.
Several agricultural companies and companies in the seed business are listed in the table below by market cap with most recent % year-over-year revenue growth and valuations (source: finance.yahoo.com except for most recent year-over-year revenue growth from Morningstar.com):
Growth in Revenue current yr
Market Cap ($M)
SANW has grown its revenue the fastest so its stock is not the cheapest, and its financial statements are far from "pristine." Even with its huge recent SG&A costs averaged over 5 years, SANW has not yet provided economic value to shareholders: my calculations of ROIC were negative for 2009-2011, about 5% for 2012, and <1% in 2013. I did not compute cost of capital but it is surely greater than its returns on capital.
Recommendation. Short-interest is about 8%, down from what it was when the stock reached its peak in March, but days to cover has increased (source: NASDAQ.com):
Shorts may decide to cover at the $7 mark. If there is any catalyst that could send this stock toward multi-bagger status, which is what I ultimately expect, they will scramble to cover.
SANW is not a conservative, value investment, and has been a sell ahead after its last two quarterly earnings reports for those who bought the stock largely based on the company's 2012 profitability or on its upward momentum in early 2013. However, for those who want to invest in producing food for emerging markets, this stock - with recent analysts' target prices of around $14 - offers huge upside from the current $7 price, and is worth a small portion of a portfolio as a long-term investment.