FMC Corp's Exceptional Performance Comes At A Cost

| About: FMC Corporation (FMC)
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Summary

FMC has delivered incredible growth from its ag chemicals business, where its variable cost structure and low R&D intensity support strong margins.

Leading positions in several health and nutrition markets create a valuable second driver of growth.

Spinning off the Minerals business will allow this business to once again invest in growth and expansion projects.

There are a lot of really good things about FMC Corporation (NYSE:FMC). The company's unusual model in agricultural chemicals allows for exceptional margins, and the company's food/nutrition business is a leader in close to two-thirds of its operations. The only fly in the ointment is that investors are well aware of FMC's exceptional growth and its different model, and the valuation on these shares is not low.

Pursuing A Different Mix In Ag

FMC's agricultural chemical operations are unusual in several respects. The company has enjoyed an exceptional run of growth, as this segment has grown reported revenue at a trailing 10-year CAGR of 48%. FMC is now one of the largest agricultural companies in the world, with meaningful share in both herbicides and insecticides.

FMC doesn't take a conventional approach to this business. The company doesn't engage in basic production, choosing instead to use tolling agreements to source what it needs. FMC likewise does not engage in basic R&D, having sold its R&D assets to Bayer almost a decade ago. Instead, FMC uses acquisitions, JVs, and in-licensing, focusing its activities on reformulating and combining active ingredients discovered by others. This has enabled the company to generate 20%-plus operating margins, as well as creating more or less customized formulations for customers.

One of the key growth drivers for the company has been its penetration of South American markets like Brazil and Argentina. These countries have taken a big leap forward over the past decade in terms of the modernization of their farming sectors, and greater crop protection use has been a large part of that. With that, Latin America is more than half of the company's sales base.

FMC is also a little unusual in its crop exposure. A 28% exposure to soy is not so strange, nor is a 12% exposure to cotton or 11% exposure to sugarcane. What's more unusual is the sub-10% (7%) exposure to corn, a major crop in the United States.

Following in the steps of Monsanto (NYSE:MON) and Syngenta (NYSE:SYT), two of the largest ag chemical companies in the world, FMC is moving into biologicals. Biologicals are expected to become a $1 billion-plus new market for crop protection, and FMC is re-entering basic R&D (on a limited basis) to support this effort.

Health And Nutrition A Strong Second Leg

The long-term growth in FMC's Health and Nutrition has been every bit as significant as in the Ag business and this is an important second growth platform for the company. Split pretty equally between food and pharmaceuticals/nutrition, FMC sells a variety of binders and disintegrants, as well as colloidal MCC (used as a binder for drug tablets), carrageenan (used for gelling, thickening, or stabilizing food products), alginates, and more recently natural colorings, pectins, and omega-3 fatty acids.

A lot of FMC's products fly in the face of movements to eat natural, unprocessed food. Given the growth in packaged food, and the significant under-penetration in emerging markets, I doubt it will make much of a difference.

Minerals Going Off On its Own

FMC Corp recently announced that it intended to spin off its Minerals segment as an independent company. Contributing about one-quarter of the company's overall revenue, this is business is split unequally between soda ash (around three-quarters of revenue) and lithium (one-quarter). FMC is a reasonably competitive player in both segments, but neither offer the sort of growth or returns on capital to match the Ag and Health/Nutrition operations. With that, management has been under-investing in expansion/growth projects in Minerals and the spin-off will likely benefit this operation over the long-term.

FMC has about one-quarter of the U.S. market for soda ash (used extensively in making glass), and by virtue of its mining operations in Wyoming it is a lower-cost supplier. In the lithium business, FMC's brine operations have a higher operating cost than either SQM (NYSE:SQM) or Rockwood (NYSE:ROC), but the company still compares favorably to Chinese brine producers or those using spodumene. Lithium is a solid #3 in the market, and one that sells a larger-than-normal percentage to higher-value markets like polymer chemistry and pharmaceuticals.

Good Growth Prospects, But Not Cheap Prospects

Spinning off the Minerals business isn't going to do all that much to help the "new FMC", other than to eliminate some cyclicality tied to the more economically-sensitive soda ash and lithium markets. Seeing as the Ag business was generating approximately four times more cash than Minerals and growth investments in the Minerals business were being avoided in lieu of higher returns from Ag and Health/Nutrition, it's not as though there's going to be a big change in priorities.

I am bullish on the prospects for both the Ag and Health/Nutrition operations. Well-proven improvements in yield and rising farmer incomes are leading to greater use of ag chemicals and FMC's different approach seems to make it a more flexible and responsive competitor. There are some risks that greater use of seeds from Monsanto and DuPont (DD) containing insect resistance traits will limit chemical growth, but those traits tend to be highly specific and still leave ample room for FMC's other products.

The biggest problem I see is the value that the market has already assigned to FMC's prospects. The shares trade just a little bit below a forward EBITDA of 12x, and while that is in line with analyst expectations for EBITDA growth over the next three years, that's a steep premium to the historical average of around 7.5x.

The Bottom Line

Some investors will likely take a viewpoint of "don't worry about the valuation, just buy the growth". I do believe that FMC can continue to post industry-leading growth, but ignoring valuation doesn't fit with my own investing approach. With that, I'm going to remain a spectator on this stock, though I am quite impressed with the quality of the company, its competitive edge(s), and its prospects for above-average growth in the coming years.

Disclosure: I am long MON. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.