Agribusiness concern Monsanto (MON) took another solid step forward in repairing its relationship with the Street on Thursday morning, reporting earnings that were nicely ahead of even the highest published estimates from the Wall Street community. With seed demand apparently running strong, the herbicide business stabilized, and a fast-developing pipeline, Monsanto is looking really good heading into 2012.
A Great Result In A Bad Quarter
Monsanto's first quarter is usually a seasonably OK one – a quarter where there is little activity in North America, but where Latin America is becoming increasingly important. This time around, though, results were good. Revenue jumped 33%, with 32% growth from seeds and 34% growth from the herbicide business.
Within seeds, corn was exceptionally strong (up 46%) due to strong sales in Latin America (Brazil and Argentina, mostly). Seeds also got a boost from a quarterly pull-forward of cotton seed sales (up 73%) to Australian farmers. Soybeans were less impressive (up 7%) and vegetable seeds were down 14%.
Monsanto also made noteworthy progress on its profitability. Overall gross margin stayed flat at about 45% as strong seed profitability (nearly 60% GM) offset weaker margins from the herbicide business. The company also was able to show some solid operating leverage, as operating income nearly tripled from last year on the higher revenue/gross profit base.
Hundreds Of Millions Coming Down The Pipeline
Hopefully Monsanto investors are already going to the company's website and looking at the quarterly updates that the company provides, as they offer a wealth of information. It's worth noting that the company saw 14 projects advance in the pipeline. Monsanto now has a 3rd-gen corn rootworm trait in phase 3, a 3rd-gen Bollgard cotton in phase 3, a higher-yield corn in phase 3, and a drought-tolerant corn in phase 2. All told, these could be worth several hundreds of millions of dollars in the coming years.
Monsanto's pipeline discussion was also interesting in what it revealed about win rates in much of the corn belt. Granted, seed companies rarely ever publicly acknowledge weakness (lest farmers listen in and start demanding price concessions), but Monsanto seems to really be regaining momentum against DuPont (DD) and Syngenta (SYT).
Although DuPont made much of its supposed yield advantages last year, the final numbers weren't as strong as the initial results, and it looks like DuPont may have courted some of the same over-promise/under-deliver problems that bedeviled Monsanto recently. What's more, if Monsanto beats DuPont and Syngenta to market with drought-resistant traits that are as good as advertised, this could be a real share-driver in Monsanto's favor.
Will The Real Economy Please Step Forward?
Interestingly, none of the major seed companies are talking about any worries for this planting season in North America. I say interestingly because the major fertilizer companies, like Mosaic (MOS) and Potash (POT) have recently started cutting production due to weak pre-season sales and building inventories. What's more, there have been more than whispers that this is a product of the uncertain macroeconomic picture.
Certainly seeds and fertilizer are not interchangeable, but it's curious to me that one side of the agribusiness sector says things are great while the other side is taking a cautious tone. The seed companies have this one right. Although land prices have been soaring and machinery from the likes of Deere (DE) has been getting more expensive, crop prices have stayed strong and all indications are that this will be a robust planting season.
Expect A Step-By-Step Improvement
Although Monsanto had a very strong quarter, investors should not expect the company to rush to boost its guidance. In years past, seed companies have responded to big guidance changes with aggressive price action. In other words, the risk is that if Monsanto seems a little too confident, DuPont and Syngenta will undermine that with price cuts in an attempt to preserve share. By the same token, given the strong pull-forward in cotton, management's guidance was actually quite strong as it relates to the next quarter.
The Bottom Line
With Monsanto having apparently done a very good job in repositioning its “productivity” business (largely the herbicide Roundup) and repairing its image with North American farmers, I'm sorely tempted to clip a half-point off of my discount rate on the free cash flow model for these shares. Doing so would mean about a 10% bump in the price target – lifting into the mid/high $80s.
With or without that adjustment, I'm hanging on to my position, even while admitting that there has already been a decent rebound in these shares, and it is not the cheapest stock out there.
Disclosure: I am long MON.