Analysts at JPMorgan recently upgraded Monsanto Company (NYSE:MON) from neutral to overweight after the company reported better-than-expected Q2 FY 2014 financial results. Additionally, the firm also considered the company's improving prospects from the healthy commodity outlook and the improvement in herbicide pricing. This caused the firm to raise the price target on Monsanto's shares from $115 to $125. The stock is currently trading around $114.28 indicating that the stock presents an investing opportunity with a handsome upside potential. Therefore in this article, I will analyze the major factors that have contributed towards improving the company's performance so far along with the determining factors that will contribute to the company's growth in the coming years.
The company is a global supplier of agricultural products for farmers. The company operates two business segments: the seeds and genomic segment and the agricultural productivity segment that sells seeds, biotechnology trait products, and herbicides to farmers. These products work as solutions that improve productivity, reduce the costs of farming and help to produce better foods for consumers and better feed for animals.
Let us begin by discussing the company's recent quarter results and determine the drivers behind the company's current financial performance.
A Glance at the Recent Quarter Earnings
The company reported its Q2 FY 2014 earnings on April 2nd, 2014. The company earned $1.67 billion or $3.15/share in Q2 FY 2014 up 13% from $1.48 billion or $2.74/share earned in Q2 FY 2013 (see table above). On average, analysts expected the company to earn $3.07/share in Q2 FY 2014 according to Thomson Reuters I/B/E/S. The reasons behind the improvement in the company's EPS include the positive impacts of economies of scale as the company successfully expands its business. This can be seen from the company's Q2 FY 2014 gross profit margin that expanded from 56% to 59%.
The company's net sales rose to $5.8 billion in Q2 FY 2014 up 7% from $5.5 billion in Q2 FY 2012 and in line with analysts' expectations. Among departments, the net sales from the company's seeds and genomics segment amounted to $4.6 billion for Q2 2014 up 7% in comparison to the previous year's comparable quarter. This indicated that 79.3% of the company's Q2 FY 2014 net sales were generated from the company's seeds and genomics segment making it the major revenue driving segment of the company. The company's agricultural productivity segment includes the Roundup herbicide business that contributed $1.2 billion or 20.7% to the company's total net sales for Q2 FY 2014 up from $1.1 billion made in Q2 FY 2013.
Source: MON Form 10-Q
The 7% growth in the company's major revenue driving segment, seeds and genomics, came mainly from exceptional strength in soybeans that recorded a 21% increase in its net sales. Corn seed and traits is the major revenue driver of the company representing 73.5% of the seeds and genomics segment's total sales and 58.5% of the company's total net sales as shown in the table above.
The major revenue driving segment along with its corn and soybean seed and traits businesses are also major bottom-line drivers of the company (see table below).
Source: MON Form 10-Q
Therefore, I will now proceed by discussing the outlook of the corn and soybean seed and traits markets for the company but before that let's have an overview of the forecasts for the global seeds market.
Global Seed Market Outlook
The global seeds market was worth $44,122.2 million in 2012 and is estimated to reach a worth of $85,237.6 million by 2018 increasing by a CAGR of 12.1% from 2013 to 2018. Soybean dominates the global oilseed seeds market while corn possesses the majority share of the global grain seeds market. Both soybean and corn crops are predicted to grow at similar CAGRs of 12.5% from 2013 to 2018. The rising demand and consumption of seeds with biotech traits has turned into a primary driver of this growth in the global seed market. Therefore, Monsanto has more opportunities to capitalize from this growth in the global seeds market.
In terms of geographic regions, North America is the biggest seed market followed by Europe and Asia-Pacific. The U.S. is the largest seed market in North America while Brazil currently leads the Latin American market. China and France are the prevalent markets in Asia-Pacific and Europe respectively. CAGRs of 12.0%, 12.2% and 13.1% for the seed markets in North America, Asia Pacific, and Latin America respectively are predicted for 2013-2018 while Europe will remain the main market for fruits and vegetables. This reflects the fact that Monsanto has more potential to increase its sales outside of the U.S.
Now, let's take a deeper look at the prospects for the company from the corn and soybean markets.
Corn and Soybean Outlook: Opportunities and Growth Potential
According to Monsanto, the global demand for corn will increase as a result of rising global population and income growth that will result in higher food consumption and demand and ultimately higher crop yield over the next several years. It is forecasted that by 2050, the world's population will reach 9.2 billion reflecting a 34% increase from now. Additionally, much of this growth will come from developing countries like Brazil that hold the biggest areas of arable land in the world for agriculture. Thus, in order to cater to the higher food demand from rising populations and income global food production must rise by 70%. Global corn consumption, in addition to these factors, and the rising use of corn in the manufacturing of ethanol as an alternate fuel type will also drive the growth of the corn market. The commercial corn market is expected to reach $24.26 billion by 2018.
Despite expectations of lower plantings in the United States this spring, Monsanto was able to log 4% growth in its corn seed and traits sales in Q2 FY 2014 in comparison to the Q2 FY 2013. The market prospects in Eastern Europe and expansion in Latin America helped the company's corn business. Therefore, the company still has great opportunities for its corn business outside of the U.S.
While corn is the company's primary trait opportunities from soybean have more growth potential and the company is placing itself in order to capitalize on those opportunities.
According to the latest report by the U.S. Department of Agriculture the projected soybean acreage is likely to rise by 6% to 81.5 million acres in 2014 whilst corn acreage is estimated to drop by 4% to 91.7 million acres.
Soybeans contributed just 14% to Monsanto's total net sales in Q2 FY 2014 but its gross margin was 65.73% almost close to the 65.99% earned by the company's corn business. This reflects the fact that soybeans are as profitable to Monsanto as corn and reveals the company's strength in preserving its bottom-line even if its business from corn seeds slows down. Considering these factors along with the growing market soybeans will remain the subject for the company's growth in 2014.
In addition to all this the company has also engaged in activities that will position it to capitalize on the growing soybeans market.
The company is currently engaged in launching its biggest-ever soybean product offerings in Latin America that go beyond the features of the existing products and pool tolerance to glyphosate herbicide, defense against caterpillars, and yield expansion. Monsanto increased to 3 million acres of its Intacta Roundup Ready (RR) 2 PRO soybeans that grew the company's soybean segment. This great launch of a soybean trait by the company will keep providing an innovative platform for Latin American soybean cultivators.
The more than four bushels per acre yield harvest advantage compared to the first generation of Roundup Ready soybeans has provided the company with an edge over its competitors that include Dow Chemical Co. (NYSE:DOW) and E.I du Pont de Nemours & Company (NYSE:DD). In addition to being ahead of the competition the company's licensing agreement with DuPont means its opponents are paying for the opportunity of working with Monsanto on the next generation of soybeans. DuPont got into technology licensing agreement with Monsanto in 2013 because it is related to its next-generation soybean technology. Because of that DuPont will pay Monsanto royalties on future soybean sales. DuPont began offering RR 2 Yield soybeans in the current year and will offer RR 2 Xtend from 2015. DuPont will pay $200 million annually from 2014 and Monsanto will book the receipt of the first installment in Q2. Furthermore, DuPont will pay a minimum annual royalty of $950 million from 2018. Hence, the cross-licensing agreements with its rivals should contribute enormously to the company's growth.
This will make soybeans key to Monsanto's growth in the coming years and the company is anticipating a $1 billion net sales growth opportunity in its soy seed and trait business over the next 5 years supported by Intacta, Roundup Ready 2 Yield, and the Roundup Ready 2 Xtend (awaiting approval) platforms.
Prospects from Emerging Markets and Computerized Agriculture Tools
Monsanto has led the industry of the bioengineered-seed business for an age and lately initiated expanding its footprint in emerging markets like Argentina, Brazil, and parts of Asia. Moreover, there are many opportunities for global expansion for the company as markets like Eastern Europe, South Africa, India, and China are still under-penetrated in terms of advanced seed varieties. It may be surprising to know that China is one of the biggest corn-growing countries in the world, growing around 70 million acres almost equal to 80% as much as the U.S. that grows 90 million. Although players in the industry such as Syngenta AG ADR (NYSE:SYT) have a significant existence in some of these markets, the company is not as robust in the core corn and soybean markets that Monsanto aims to target.
Computerized Agriculture Tools
While the bulk of Monsanto's business comes from genetically modified seeds and herbicide the company is also making investments in computerized tools for the agricultural sector.
During the previous quarter the company announced an agreement with the U.S agricultural distributor WinField to explore cooperation on agriculture-based information technology. In October, the company incurred $930 million to acquire Climate Corp., a Silicon Valley startup that makes use of weather forecasting and data analysis to growth harvest yields. This technology is referred to as precision-farming and uses advance techniques such as real-time data collection regarding weather, soil, and air quality to make smarter decisions regarding crops. According to Alix Partners' report the demand for precision-farming products in mature markets is expected to rise by 10% per annum over the next five years. Emerging markets have further growth potential due to lower penetration so the demand growth for precision-farming technologies is expected to rise by 10-15% per annum in these regions over the next 5 years.
TheStreet Ratings team rates Monsanto Co. as a "buy" with a rating score of B. The company has a dividend yield of 1.53% along with the balance sheet strength that includes a 0.2 debt to equity ratio in comparison to the industry average of 0.4. The current major top and bottom-line drivers of the company will keep contributing to the growth of the company in the coming years. The company's investment and introduction of innovative solutions has provided the company with a competitive edge over its industry peers. The handsome growth potential for the company comes from the emerging markets and soybeans business. Moreover, the company is also investing in capitalizing on the growth prospects from the precision-farming industry by acquiring relevant technology. All of these factors indicate the bright future of the company making it a worthwhile investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.