While the market's reaction to Monsanto's (MON) earnings has calmed a bit as of this writing, investors were initially quite unimpressed with the results. While missing a quarterly number and/or lowering guidance relative to consensus is never a good thing, it would be a mistake to assume that Monsanto's seasonally weak fourth quarter gives a good read on near-term results. Given this company's technical leadership and management's "under-promise, over-deliver" inclinations, I'm in no hurry to cash out of these shares.
Q4 Ends The Year With A Thud
It's perhaps a little unfortunate that Monsanto uses a reporting cycle that leads to its fiscal fourth quarter often being weak, as I believe it sometimes obscures the progress that the company has made.
In any case, revenue dropped about 6%, with a 10% drop in seeds and basically flat results in "productivity" (herbicides, mostly). Although revenue from soybeans was up nearly 50% and vegetable revenue rose 6%, the two combined are smaller than corn (which declined 12%).
Profits were likewise down for the quarter. Gross margin eased off one and a half points, with gross margins in seeds down 660 basis points. Adjusted operating loss more than doubled from last year, with the company spending significantly more on R&D than most analysts had projected. All in all, the company missed average estimates by a couple of pennies, depending on which source you use.
Plenty Of Positives Leading Into Fiscal 2013
The operational data on Monsanto continues to look pretty strong. The corn harvest is still underway, but it looks like Dekalb is showing an eight bushel per acre advantage (a little more than 5%), and you can bet that the company is going to point this out to farmers who buy their seed from DuPont (DD]) or Syngenta (SYT).
Monsanto continues to make progress with its pipeline as well. Drought-tolerant corn (DroughtGard) has showed about a five bushel per acre advantage, and this should be a major new product. A little further back, Monsanto also has higher-yielding corn traits, a rootworm-resistant product, and corn with improved nitrogen utilization in development. On the soybean side, Monsanto is still looking for big things from its Intacta product, which could add $80 per acre in incremental value to farmers. That said, it's likely to be a fiscal 2014 contributor and not much of a factor next year.
Monsanto has also started to get more active in RNAi-based crop technologies. Monsanto formed a strategic alliance with Alynlam (ALNY) a little more than a month ago, and though the upfronts were small, the long-term potential could be meaningful. Monsanto is looking to use RNAi (sometimes called "gene silencing") to develop biopesticides - spray-on products that could control weeds, pests, or plant disease without altering the genetic structure of the crop itself.
This could be significant in at least two respects. First, it could be a workable compromise for governments (the European Union in particular) that oppose genetically engineered seed traits. Second, it could allow Monsanto to expand its fruit and vegetable business - developing engineered traits for individual vegetables or fruits isn't always (or often) cost-effective, but a spray-on product that could be used with multiple crops could have real potential.
Last and not least, Monsanto is also rolling out new service offerings under an Integrated Farming System (IFS) program. This service will collect data on a farmer's land (including details like soil quality, climate, etc.) and create seeding recommendations. In theory, at least, this could add perhaps as much as 10 bushels per acre to yields.
But Challenges Remain
Of course, Monsanto being Monsanto, there are challenges as well.
Although a recent published study by Gilles-Eric Seralini on the risks of Monsanto corn (NK603) had several flaws (including using a rat strain prone to tumors, using unconventional statistical methods, presenting the data with no mention of food consumption, and using a control group of 20 rats), it still brought more negative attention to the debate over the safety of Monsanto's products. This debate is likely not going to disappear anytime soon, and Monsanto seems far more leveraged to the negative news flow than DuPont, Syngenta, Bayer, or BASF in the advanced crop space.
Monsanto also has to find a balance between leveraging its technology and keeping customers happy. I believe the company has already reformed a lot of its worst habits, but there's likely always going to be an element of risk when it comes to setting prices on a year to year basis. At least for the next year, though, it seems unlikely that either DuPont or Syngenta will be looking to compete on price - the North American drought has not only impacted farmers, but also these seed companies that have to literally grow their product.
The Bottom Line
I am a little concerned that Monsanto's beat-and-raise streak could be at an end, and that analysts have caught up to (and overshot) the company's actual financial performance. As I said earlier, though, it's difficult to judge on the basis of a seasonally soft quarter. Nevertheless, there's likely to be a little more risk going into the fiscal first quarter and the company needs to deliver a good result.
As far as long-term holdings go, I'd much rather own Monsanto than a fertilizer company or farm equipment company. Stocks like Potash (POT) and Mosiac (MOS) can make for very good trades and Deere (DE) is a quality company, but I like the fact that farmers have to buy Monsanto seed every year and that the company can support its efforts with clear technological advantages.
Even with relatively aggressive assumptions (9% annual compound free cash flow growth), Monsanto is not particularly cheap today. As I've said before, I'd rather hold Monsanto than buy a cheaper, lesser, agricultural play but I would also recommend that new investors consider waiting for a pullback before buying these shares right now.