The widely followed “stock-to-use” metric suggests that ending inventories of corn will be less than 10% of annual consumption, a level not seen in over 40 years. In 1996, the stock-to-use ratio declined below 20%, causing a nearly 200% increase in corn prices. In fact, if we were to assume flat demand next year, and yields were to improve at the same rate they have been improving (about 8% year trend), we would end the year with a shortage of corn bushels, forcing the U.S. to become a net importer.
What’s troubling is that most of the data suggests demand will actually increase next year, making continuedgrain price rallies more likely. Currently there are approximately 100 ethanol plants in operation in the US. Over the 2007-2008 time period, about 85 additional ethanol facilities are expected to complete construction, and begin operation, further increasing demand for agricultural inputs. Furthermore, emerging economies are becoming more and more dependent on corn feed as their populations demand more protein in their diets.
As more acreage is planted for corn, less is planted of other crops, driving up their prices as well. It is likely that as more and more technological advancements in cellulosic ethanol and other bio-fuels are made, the role of agribusiness and improving yields will be increasingly higher on the value chain.
These exciting developments in agriculture encouraged me to focus my screening efforts within this industry. Importantly, I sought to find a company with exposure to these trends, but one that would fit within my disciplined investment process and met my fundamentally based criterion, which led me to Syngenta (SYT). Syngenta is a Swiss- based company that manufactures and markets crop protection and agricultural seed products. The company was formed in 2000, when the agri-business segments of Novartis and AstraZeneca, where spun-out and merged together to more effectively compete with DuPont and Monsanto.
Here are some of the main points of this thesis:
1. Crop protection business is a “cash cow” that can be used to fund growth
Today, Syngenta is the global leader in crop protection (insecticides, fungicides) with about 20% global market share (market size is roughly $30billion). This segment accounts for about 80% of the company’s current sales mix. The primary reason that the stock trades at a discount is because of its exposure to this slower growth business. Most analysts believe that about 5-10% of the crop protection market is at risk from new seed technologies, which limits the growth attributable to acreage growth and new products to only 1-2% per year. In my view, while this is a slower growth business, it still offers very strong margins and cash flow to fund other growth initiatives within the business. Furthermore, I expect the introduction of several new products to allow the company to charge higher prices and generate stronger profits, even if the top-line growth moderates.
2. 2007 and 2008 product introductions in bio-tech (GM) seeds can significantly accelerate profit growth
The company also has a significant presence in seeds, where it is the #3 player globally, with about 10% market share of the $15B world seed market, and about 15% of the U.S. market. In the seeds business the primary competition is from Monsanto, which has about 30% of the market, and DuPont, the #2 player with about 25% share. The seed market is therefore highly oligopolistic, and has significant barriers to entry and reasonable pricing power. The primary knock on Syngenta is that it is late to the game in the faster growing biotech (genetically modified) seed market. Currently, it takes about 4 years for a seed to be developed and to sufficiently breed enough quantities of it to distribute. While DuPont and Monsanto have debuted their “double” and “triple stack traits” recently (double-stack is seed with two significant biotech traits), Syngenta was somewhat late, and won’t offer a double stack trait until mid-2007 and a triple stack in 2008 (just recently approved by U.S. agencies).
That said, if Syngenta migrate only a small % of its conventional seed customers toward its new products, it will generate significant profits. The double and triple stack products generate nearly twice the profitability as conventional seeds and will have a powerful impact on net income.
3. Syngenta has the best business fundamentals in the peer group.
Syngenta has stronger return on equity trends (evidence of well managed company), a better balance sheet, and generates more free cash flow than peers.
4. Syngenta, because it is slightly late to the “bio-tech party”, and has some slower growth segments trades at a significant (and undeserved) discount to Monsanto.
This disconnect will be likely be narrowed if the company can show just moderate amount of success with new product introductions, and others begin to see the relative value in this name. In fact, assuming just moderate margin expansion and EPS growth of about 14% over the next 5 years, a discounted cash flow analysis yields value 30% higher than the current price. Monsanto trades at over 34 times earnings, while Syngenta trades just slightly above the market multiple at 17.5X (almost 50% of Monsanto’s valuation!!). DuPont trades at about 15X, but has about 50% of its business tied to highly cyclical housing and automotive markets. In my view, this is a “safer” way to play this trend in agriculture.
Disclosure: author is long SYT.