Second-quarter results show strong operational improvements will yield higher earnings.
Fundamentals such as a solid financial position with reasonable debt levels are very appealing.
Monsanto has become more balanced and well diversified.
Shares of agriculture giant Monsanto (NYSE:MON) have grown impressively over the past two years. While we don't currently own the stock, we have become strong supporters of the company's operation. But at times, it seems as if we're in the minority.
The company is considered "evil" by many critics, given that Monsanto sells genetically enhanced seeds, which are seen as "unnatural." From an investment perspective, however, this company is a wealth-building operation. And in the company's strong second-quarter earnings report, there are no meaningful signs of slowing down.
Just like fertilizer to a plant, Monsanto management continues to harvest ways to grow various aspects of the business, even parts that were considered dormant. Second-quarter revenue arrived to $4.65 billion, up 7% year over year. This was a welcomed surprise, given that management is known to "under-promise."
Revenue was helped by a 21% jump in soybean seed and traits. Corn seed and traits edged up more modestly at 4.1%. Even more impressive, however, was the balance that Monsanto demonstrated among its segments. For instance, there were concerns last year that the company's agricultural productivity business, which included herbicides such as Roundup, was doing all of the heavy lifting.
But unlike previous quarters, Monsanto's core seed operations regained its "main course" status. Investors should be encouraged by this. Likewise, corn is Monsanto's main revenue-driver. And there were concerns from analysts that this figure was going to be weak. They underestimated management's ability to adjust. Corn revenue arrived at $1.18 billion, more than 5% year-over-year.
This tells us that all of the segments are moving in unison. Monsanto has become more balanced and well diversified. What's more, the fact that gross margin jumped to 59.1% from 56.1% shows that management's efficiency improvements have begun to pay off. This created a 13% jump in net income, helped (in part) by a product costs decline of 0.7%. But management is not satisfied.
The company has planted optimism that there are more share gains ahead. Management said it wants to expand the company's footprint in areas like "precision farming," a practice that uses GPS and other technologies to help farmers boost crop yields. Recall Monsanto spent $930 million to pick off Climate Corp, a farm analytics company that specializes in customized weather information. So this deal should pay off handsomely.
Analysts at JPMorgan agree. Following Monsanto's strong report, JPMorgan upgraded the stock to overweight and upped its price target to $125 a share. With Wednesday's close of $115.08, this suggests roughly 9% upside to current value. Given Monsanto's market position in corn and soybeans over rivals like Syngenta (NYSE:SYT), JPMorgan's target seems conservative.
There are plenty of factors to support a higher share price. First and foremost is Monsanto's strong revenue growth. Likewise, fundamentals such as a solid financial position with reasonable debt levels are very appealing. Plus, it's hard to not be impressed with the company's record of earnings per share growth and notable return on equity, which sits at 20%.
There are areas of improvement such as operating cash flow as a percentage of revenue. It would help if these were stronger, currently at 21.7%. By contrast, DuPont (NYSE:DD) and Syngenta carry a cash-flow to revenue of 11% and 9%, respectively. The good news though is that Monsanto outperforms both companies from a debt-to-cash ratio, which is at two-to-one. Both Syngenta and DuPont carry more debt than they have cash on the books. In that regard, we feel that Monsanto's overall strengths outweigh the company's weaknesses.
And when factoring that management backed its full-year outlook, saying it expects to post a smaller loss in the fourth quarter compared to previous years, this suggests more efficiency improvements, cost-cutting and possibly better pricing leverage. From my vantage point, this is a company that's operating on all cylinders. And we support JPMorgan's target of $125.
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 Wall Street Playbook's retail sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.