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The severe drought has been a fuel for the prices of agricultural commodities, especially corn and soybeans, whose yields were decimated as a result of excessively hot temperatures. Consequently, to make up for lost yields this season, we expect farmers to seek maximum crop yields in the next planting season, which will lead to a huge increase in demand for agricultural nutrients like seeds and fertilizers, along with other agricultural chemicals like herbicides. So, we are buy-rated on Monsanto Company (NYSE:MON), which is a leading provider of agricultural products like seeds, herbicides, and other biotechnology trait products. In addition, the company is also in the process of obtaining approvals from foreign governments regarding its newly-developed drought-resistant variety of seeds, which also adds to our bullish sentiment. The company's earnings base is least impacted by the economy, and its agri-centric operations, leading market position, along with sustainable growth profile, make us enthusiastic about the company, despite its estimated forward P/E of 21x.

Drought, Crops and Seeds

The dreadful drought conditions have significantly compromised crop yields, resulting in a huge spike in their prices. The corn futures have surged from almost $5/bushel in June to the current levels of $7.5/bushel, and set a record high level of $8.49/bushel on August 10. Likewise, soybeans also sparked from $13/bu to more than $16.5/bu as of late, after touching record highs of $17.94 early this month. Subsequently, amidst low crop output this year, we expect strong plantings in FY2013, which will be beneficial for Monsanto.

Goldman Sachs Upgrade

In a client note yesterday, Goldman Sachs (NYSE:GS) added Monsanto Company to its "Conviction List", and raised its target price from $100 to $110. Goldman attributed MON as a "high quality growth franchise", with an average EPS growth rate of 27.4% over the last seven years. In addition, the company has been able to beat its initial guidance in all of these years, except the challenging FY2010. GS is also impressed with the fact that MON is a one of the chief market leaders. Goldman expects strong crop plantings in FY2013, which will continue to benefit Monsanto.

Genetically Engineered Drought Resistant Seeds

Monsanto has also developed a drought-resistant variety, Droughtgard ™Hybrids, but unlike its competitors' products, DuPont (NYSE:DD)'s AQUAmax and Syngenta AG's (NYSE:SYT) Agrisure Artesian, it possesses genetic material from other plants as well, in addition to the required corn traits. Furthermore, Droughtgard is the first-of-its-kind drought solution, as it uses biotechnology unlike its rivals. Currently, it has obtained the approval of the United States Department of Agriculture (USDA), but is pending regulatory approvals from foreign governments before a commercial launch, which is expected later this year.

According to OptionMonster.com's Jon Najarian, "The biotech stock was up 62 percent over the past two years, a trend that could continue as the company's genetically engineered, drought-resistant seeds stand to be in more demand over the next year or so. I think Monsanto's is doing a lot of things right."

Valuations

On the basis of valuations, MON appears an expensive option because of its forward P/E ratio of 21x and EV/EBITDA of 12x. In addition, its share price, year to date, has also augmented the most among its peers (30.1%), and its dividend yield is also the lowest (1.7%). Still, its market leadership, successful growth profile, and the fact that the company is less sensitive to macroeconomic conditions, make us recommend a long position in its stock. In addition, the stock's forward P/E of 21x is in line with its historic average of more than 22x.

 

MON

DD

SYT

Forward P/E (1-year)

20.96x

11.4x

N/A

EV/EBITDA ((NYSE:TTM))

12.4

10.06

-

Dividend Yield

1.70%

3.40%

2.00%

Share price performance (YTD)

30.10%

12.75%

25.73%

Source: Yahoo Finance, Bloomberg

Source: Buy Monsanto: We Agree With Goldman Sachs' Upgrade