Just as one missed quarter often leads to a few more missed quarters as analysts struggle to recalibrate their expectations, so too does it work on the positive side. Right now Monsanto (MON) is enjoying a resurgence as the company moves on from marketing and pricing missteps that gave new hope to DuPont (DD) and Syngenta (SYT). Not only are the company's yield advantages reestablishing its leading position, but the company continues to advance a pipeline that could deliver multiple blockbusters through the end of the decade.
Another Beat And Raise
Monsanto delivered 15% revenue growth for its fiscal second quarter, as both seed and herbicide revenue came in ahead of expectation. Strong corn plantings and renewed momentum vis a vis DuPont helped fuel nearly 18% growth in corn, while soybean revenue rose 12%.
Monsanto also did well on its margins. Gross margin expanded about a point, while operating income growth of nearly 22% fed a nearly two point improvement in operating margin. Not surprisingly, Monsanto continues to invest substantial resources in its ongoing R&D programs.
Monsanto management also closed out its earnings with yet another boost to guidance. Management added a few pennies to the EPS guidance and about $300 million in incremental free cash flow. Given that expectations and valuation are already high, some may be disappointed at the scale of this boost, but Monsanto management is pretty clearly trying to re-establish an under-promise/over-deliver reputation with the Street.
Growth Both Internal And External
Monsanto is clearly looking to advance a two-pronged growth strategy, matching superior R&D with ongoing international expansion. While Monsanto has a large lead on DuPont and Syngenta in Brazil and Argentina, there is still more room for growth. Argentina is still about a generation behind the U.S. in trait usage (moving from double-stack traits to triple), while Brazil is even further back in terms of double-stack adoption.
China continues to be a hot topic with Monsanto, as several writers and analysts parrot management's position that China's agricultural productivity is on par with 1970s-era America or Brazil of a decade or so ago. While there is indeed huge potential in China (not many realize that China is the world's second-largest corn producer, with about three-quarters of the acreage of the U.S.) for corn and soybeans, there is likewise significant potential in markets like Eastern Europe/Russia and Australia, assuming that regulators there continue to move in a more pro-GM direction.
While these international opportunities are large, they are going to take a while to mature. In the meantime, investors shouldn't sleep on the considerable pipeline potential at the company. The company is in the lead with drought-tolerant traits, and an upcoming triple-stack soybean launch in 2014 (Xtend) could be a big winner if early signs of 5-10% yield improvement hold up.
All in all, there could be more than four $500M+ potential traits close to market and the value of the pipeline alone could be close to $40 a share (some of which is clearly already in the share price). Monsanto will have to share some of this with its development partner BASF, but there's plenty to go around. What's more, while over 40% of the company's R&D budget is concentrated on corn, the company is also making sizable commitments to expanding its oilseeds, cotton, and vegetable traits offerings.
The Bottom Line
Expectations are already running hot on Monsanto. Free cash yield (free cash flow divided by enterprise value) is below 4% based on 2012 estimates, and 10% is usually the breakpoint for "cheap". While faster uptake in markets like Brazil, China, and Russia could certainly boost future numbers, a cash flow model that assumes 8% compound free cash flow growth over the next decade (versus 11% on a trailing basis) still produces a target price roughly around today's price.
So why hang on to a stock that's already so expensive? For starters, there is a momentum angle - the sell-side still hasn't caught up to the strength of the business and there could be a few more beat-and-raise quarters left in the tank. Secondly, I would much prefer to own a superior company at fair value than an inferior company at a discount. Accordingly, I am in no great rush to harvest profits in my Monsanto position.