Monsanto Company (NYSE:MON)
Q3 2016 Earnings Conference Call
June 29, 2016 9:30 am ET
Hugh Grant - Chairman, Chief Executive Officer
Brett Begemann - President, Chief Operating Officer
Pierre Courduroux - Senior Vice President, Chief Financial Officer
Robert Fraley - Chief Technology Officer
Laura Meyer - Investor Relations
Don Carson - Susquehanna
PJ Juvekar - Citi
David Begleiter - Deutsche Bank
Chris Evans - Goldman Sachs
Christopher Parkinson - Credit Suisse
Steve Byrne - Bank of America Merrill Lynch
John Roberts - UBS
Jeff Zekauskas - JP Morgan
Greetings and welcome to Monsanto Company’s Third Quarter Fiscal Year 2016 Earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Laura Meyer, Investor Relations Lead. Thank you, you may begin.
Thank you, Christine, and good morning to everyone. I’m joined this morning by Hugh Grant, our Chairman and CEO; Brett Begemann, our President and Chief Operating Officer; and by Pierre Courduroux, our CFO. Also joining me from the IR team are Priyal Patel, Ben Kampelman, and Christa Chancellor.
Our third quarter call marks the passage of a significant portion of the northern hemisphere ag season, and today we will provide a summary of our third quarter results as well as the outlook for the balance of this year and the years ahead. This call is being webcast and you can access the webcast, supporting slides and the replay at Monsanto.com.
We have provided you today with EPS and other measures on both a GAAP and ongoing business basis. Where we refer to non-GAAP financial measures, we reconcile to the nearest GAAP measure in the slides and in the press release, both of which are on the website. This call will include statements concerning future events and financial results. Because these statements are based on assumptions and factors that involve risks and uncertainty, the company’s actual performance and results may differ materially from those expressed or implied in any forward-looking statements. A description of the factors that may cause such a variance is included our most recent 10-q and in today’s press release. The forward-looking statements are current only as of the date of this call, and the company disclaims any obligation to update them or the factors that may affect actual results.
We plan to take a slightly different approach this morning on our format, so to kick us off, I’ll hand it over to Hugh. Hugh?
Thank you, Laura. Good morning to those on the phone and thanks very much for joining us today. Today, in a departure from our previous calls, I’d like to open with a few brief comments and then pass it Pierre, who will address our third quarter results and the outlook for the year, followed by the operational outlook for fiscal year ’17 and beyond with Brett. At the end of this call, I’ll close by covering our longer term strategic view and my perspective on our unique integrated solutions vision for agriculture.
But first, let me address the Bayer proposal and other strategic alternatives directly. Over the past several weeks with the support of our board and advisors, I have personally been in discussions with Bayer’s management regarding this proposal, along with others regarding other strategic alternatives. Regarding Bayer specifically, there is no formal update at this point. We’ve said that we remain open and we believe that our efforts and continued constructive dialog could allow our joint teams to explore potential next steps.
While any value discussion is more complex given the fact that the industry is running at a low point in the ag cycle, we recognize the potential value these types of combinations create as they accelerate innovation and increase choice for farmers across a broader set of crops, geographies and production practices while improving the sustainability of agriculture around the world. We continue to believe in the value potential of the right combination.
Of course, there can be no assurance that these discussions will lead to any transaction, or on what terms. It’s clear that Monsanto remains the partner of choice in this industry, and I assure you that we’ll continue to actively explore these opportunities and pursue value enhancing strategic options.
Our belief in the long-term opportunity is unchanged and our growth prospects beyond fiscal year ’16, with our without a deal, remain strong. The global ag cycle is at a low point, and we’ve seen a series of recent economic and political challenges. These are huge events around the world that create instability. Today, however, we see potential for positive resolution on the horizon for some of these challenges, particularly for our Argentinean soybean business, for our Round-Up Ready Xtend soybean blockbuster, and the recent announcement on re-registration of glyphosate in Europe. As this tide turns, and turn it will, with the changes that we’ve made to our business, we’ll be well positioned to strengthen our leadership role in this space with our financial discipline and our steadfast commitment to innovation.
With that, let me pass it to Pierre.
Thanks Hugh, and good morning to everyone. Despite the fact that this has been a tough year and this was a tough quarter, given the events that Hugh alluded to, as a company we’ve remained focused on delivering on our strategy while taking the necessary actions to set the stage for future growth, as illustrated by the following. We have stayed true to our philosophy of pricing to the value of our innovation. We have delivered on significant strategic portfolio management and licensing commitments, resulting in an approximate $370 million EBIT contribution for this fiscal year, as compared to $274 million in 2015. We are tracking very well towards our restructuring plan savings at a cost now closer to the low end of the range of $1.1 billion to $1.2 billion while transforming and modernizing the way we work, and we have delivered on our capital allocation commitments.
This demonstrates our ability to maintain our focus on the variables we control despite an unprecedented level of challenges affecting our business. These actions set us up nicely for momentum going into the anticipated rebound in the ag cycle, with an expected return to growth in earnings per share in fiscal year ’17 which accelerates to a mid-teens earnings per share growth rate from fiscal year ’17 to ’21. With that, let’s focus on the here and now and review our third quarter results, as shown on Slide 4 and 5.
On a net reported basis, our third quarter earnings per share is $1.63, reflecting $0.54 for restructuring charges, environmental and litigation matters, and a charge for Argentine-related tax matters. The Argentine-related tax matter resulted in a charge of $219 million, which refers primarily to a valuation allowance against our deferred tax assets, mostly driven by recent cumulative losses in our Argentine subsidiary. With growth in the business, we would expect to see this allowance reverse partially or in full over time. On an ongoing basis, this translates into $2.17 of earnings per share.
Although partly offset by the benefits of share repurchases and increased row crop licensing EBIT contributions, we encountered several headwinds in the quarter. These included the expected absence of last year’s Scotts licensing agreement and the anticipated glyphosate pricing declines, but also Round-Up Ready Xtend-related costs and lower soybean volumes amplified by the delayed EU import approval, as well as lower cotton gross profit in India arising from pricing regulations and declines in planted acres. Finally, our free cash flow year-to-date is a use of $224 million as compared to a use of $789 million in the prior year, reflecting strong working capital management.
From a year-to-date perspective, our seeds and genomics gross profit margin as a percent of net sales was nearly flat at 62%. Global corn gross profit margin was down just slightly as increased COGS from lower production plans combined with discounting to counter competitive offers more than offset the mixed leaf benefit from new hybrid introductions and price increases in local currency in regions like Brazil. In global soybeans, gross profit margins declined approximately 3 percentage points primarily as a result of costs associated with the Round-Up Ready Xtend launch, which were amplified by the delayed European import approval. These more than offset the pricing benefit from increased Intacta penetration that was partly masked by the weak real at a critical point in the season. Our cotton business gross profit margin reduction was due primarily to Indian pricing controls that were enacted in the third quarter of this fiscal year, while vegetable margins improved due to lower costs arising from better operations. Finally, our other crop segment margins improved with closure of the alfalfa licensing deal with Forage Genetics. Moving to ag productivity, gross profit margins declined due to the lower Round-Up pricing and the absence of the $274 million licensing deal with Scotts.
Looking forward, we are seeing signs of a positive resolution for several of the headwinds we’ve been tracking. First, the EU Commission just affirmed that an 18-month extension of the existing authorization for glyphosate use would be completed by the June 30 deadline. In addition, we anticipate the receipt of the EU import approval for Round-Up Ready Xtend stack shortly thereafter, and finally Argentina announced an interim policy that supports mandatory testing for Intacta, leaning into what we expect to be a strong start for our southern hemisphere businesses. However, despite these positive developments and expectations, with the results of the third quarter we now expect to be at the low end of our ongoing fiscal year ’16 earnings per share range of $4.40 to $5.10, which assumes approximately $0.85 of currency headwinds. After the inclusion of the Argentine-related tax matters and the favorable change in the expected amount and timing of restructuring expense, this translates into a full-year as-reported earnings per share guidance at the low end of an adjusted range of $3.36 to $4.14.
Now let’s take a look at the individual components within our 2016 guidance, as shown on Slide 6. First, with recent revisions, we expect seeds and genomics gross profit to be down just under 5% for the full year. Importantly, exclusive of estimated currency headwinds of roughly $350 million, seeds and genomics gross profit is anticipated to be flat to up slightly. Practically, on a currency-neutral basis we expect the benefit of the alfalfa license, increased Intacta penetration and global corn volumes to offset the roughly $150 million impact of the Round-Up Ready Xtend soybean-related costs and share loss, the impact of the pricing controls in Indian cotton and declines in planted acres there.
Of the approximately $370 million of EBIT benefit from licensing and strategic deals expected in fiscal year ’16, we recorded approximately $210 million in gross profit, reflecting the one-time upfront fee related to our alfalfa traits and technology license to Forage Genetics International. We expect the remainder of the EBIT benefit, which is mostly derived from the expected $145 million gain from the sorghum joint venture and plant sale to be recorded in other income in the fourth quarter. Our ag productivity gross profit outlook is now trending towards the lower end of our range of $900 million to $1.1 billion as earlier estimates had assumed one of our smaller licensing and asset sale deals would benefit gross profit, but was ultimately recorded in other income. For the full year, we continue to expect to see a higher ratio of branded Round-Up volume as compared to the prior fiscal year; however, we expect that full-year volumes will be below our roughly 300 million gallons of capacity, but not to the point of generating material volume variances.
From a price perspective, our competitive intelligence leads us to believe that we are nearing the bottom for genetic glyphosate pricing in the market, and we are not expecting significant moves from this point forward. We remain on track to deliver $165 million to $210 million in savings from our restructuring actions in fiscal year ’16, primarily benefiting operating expenses. These savings combined with spending discipline and currency benefits contributes to our expectation that even after increased investments in new platforms, we expect to see operating spend down slightly before estimated restructuring charges and environmental and litigation matters.
Assuming the Argentine peso exchange rate remains close to a ratio of 1:14 at the close of the fiscal year, we now expect our expense net to be relatively flat year-over-year as the nearly $180 million impact from the devaluation in Argentina is now being offset by gains on non-core asset sales of approximately $170 million.
Our tax rate is expected to increase to 32 to 34% for the full year, inclusive of Argentine-related tax matters. Looking out to fiscal year ’17, we expect our tax rate to be more in the range of 25 to 27%, which is more aligned to recent prior years. Finally, the net effect of the benefit from our share repurchases, including net financing expense, should generate a net earnings per share benefit of $0.20 to $0.25, with 437 million shares outstanding at the close of our third quarter.
Consistent with our updated earnings projections and based on the possible slight delay in the close of the sale of the Precision Ag Equipment business to John Deere, we now adjusted our free cash flow guidance for the year to be in the range of $1.3 billion to $1.4 billion, as shown on Slide 7. At the peak of our working capital cycle and after the successful execution of the $3 billion accelerate share repurchase in the second quarter, our net debt to ongoing EBITDA ratio sits at 2.6 at the close of the third quarter. We expect this to revert to a ratio in the range of 2.1 to 2.2 at the end of the fiscal year, following strong expected collections.
Looking ahead to fiscal year ’17 and assuming relatively stable foreign currencies, we expect a return to growth in earnings per share, as shown on Slide 8. As we shared at Q2, our expectation is that our long term growth would not be linear, with next year marking a slower pace as we recover and reset the trajectory with the early days of Round-Up Ready Xtend penetration. This expected growth is driven by the continued penetration of our soybean blockbusters, the durability of our global corn platform, and an improved cost of goods outlook for both corn and soybeans.
From a year-over-year perspective, this growth is expected to be partially offset by declining glyphosate pricing, particularly in the first half of the fiscal year ’17, by a lower level of non-core licensing deals, and by a slight increase in spend with inflation and expected increases in commissions and incentives offsetting the benefits from our restructuring plan. We also expect a more normalized effective tax rate of 25 to 27% for the coming fiscal year. Once we get a better line of sight on the closure of the northern hemisphere crop season and finalize our operational plans, we will provide a more refined outlook for ’17.
Beyond fiscal year ’17, the opportunities significantly accelerate as the growth drivers of ’17 are expected to expand, continuing to generate the best margins among our ag peers with streamlined operations and portfolio advantages driving our multi-layered growth into the next decade. We continue to target a mid-teens compounded annual growth rate in earnings per share from fiscal year ’17 now advancing to fiscal year ’21 from fiscal year ’19, as we moved our long-range plan a notch forward. Practically, our estimated EPS for fiscal year ’19 has not changed significantly from our previous guidance. We are now simply expanding the horizon.
In closing, our financial focus remains consistent: return on innovation, financial discipline, and balanced capital allocation. These together with a sound and disciplined approach delivering on our integrated solutions strategy supports long-term growth and industry-leading ongoing EBITDA margins and return on capital, as shown on Slide 9.
With that, I will pass it to Brett to walk through the operational outlook. Brett?
Thanks Pierre, and good morning to everyone on the line. While there are factors contributing to a dynamic environment in ag today, our organization is focused on delivering against the milestones that set a foundation for rapid growth, and importantly with an optimized operating cost structure. This focus is balanced across our broad portfolio and key growth drivers, as outlined on Slide 10, whether it is our seed business, crop protection or climate, all of which I’ll update you on today in our outlook for fiscal year ’17.
Let’s begin with soybeans on Slide 11. Our soybean innovation drivers are expected to continue record-setting adoption rates toward their target opportunity, with both Intacta and Round-Up Ready 2 Xtend soybeans anticipated to make a meaningful step-up in penetration next year. Let’s start with the 100 million acre insect protection opportunity in South America, where we are on a good path to penetrate 75 million acres by fiscal year ’19.
After achieving an expected 35 million acres of Intacta Round-Up Ready 2 Pro technology penetration across South America this year, we now believe that Intacta will be planted on 45 to 55 million acres in South America in fiscal year ’17. A royalty collection system in Argentina that operates consistently and with integrity would move us to the high end of that range.
Moving to Round-Up Ready 2 Xtend soybeans on Slide 12, we now estimate that our introduction this year is just above 1 million acres across our brands and licensees. Despite the repeated delays on the EU import approval, which we expect shortly, we know that farmers want the technology and we’re producing aggressively to be in a strong position for the coming selling season. To that end, our brands and licensees have plans in place to supply roughly 15 million acres of Round Up Ready 2 Xtend soybeans in fiscal year ’17. In addition, we expect roughly $150 million of incremental cost and soybean share losses related to the launch and subsequent delays in the EU import approval to decrease by two-thirds next year.
To enable the full benefits of the system, there is also good progress on the herbicide approvals as well. The EPA’s public comment period for the over-the-top use of dicamba herbicide closed late last month, and we’re happy to share that to date of the more than 850 comments posted so far, more than 75% of those are comments from growers, dealers, academics and others in support of the new use. The EPA has indicated they expect to conclude the process for approval of the label for in-crop use of dicamba formulations by late summer to early fall.
Our plans to enable a reliable supply of those dicamba formulations at our Luling, Louisiana facility continue, and in the interim we have supply agreements in place to meet the demand for what we envision will be the number two molecule in crop protection behind glyphosate.
From a global corn perspective, as shown on Slide 13, the factor that stands out is the durability of the portfolio in a challenging environment. This is illustrated by the expectation that we held or grew our global genetic share. Although our global germplasm price mix excluding currency is expected to be down slightly for this fiscal year with anticipated stable to improving corn acres and commodity prices, we expect to see global price mix lift move to the positive in fiscal year ’17. As we finalize our price guards, we’ll share more. This lift is then expected to accelerate in later years due to performance from breeding gains. We also expect improved cost of goods from more normalized seed production plans, leading to a significant reduction in the $90 million to $100 million of headwind we experienced this year.
As we review by region, let’s look first at the U.S. We expect planted acres to be in the range of 91 to 92 million acres, and we expect to grow our genetic share on that footprint, delivering the second highest year of U.S. corn sales volume in the history of the company. With new generations from our advanced breeding programs and the next generations of corn insect control traits coming from SmartStax Pro and Trecepta towards the end of this plan, our U.S. business looks promising.
In Europe, with an estimated eight points of share gain the past eight years, we look forward to continuing to be the fastest growing corn seed brand in the region. In Argentina, with an expected lift in commodity prices and reduction in export taxes, we believe that corn acres in the country could increase greater than 20%. Given our historic share in Argentina corn, this bodes well for the season ahead and beyond. In Brazil, we also see the outlook improving. We expect that acres planted to corn will increase in the mid-single digits and that the ramp-up of VT Triple Pro traited hybrids will continue again in 2017, as farmers trade up to better insect control. I’m also pleased to share that for the upcoming summer season in Brazil, we expect double-digit germplasm price increases in local currency coming on the back of 20%-plus price increases in Brazil for fiscal year ’17, offsetting some of the currency downside.
Other notable developments occurred in our complementary crops, as outlined on Slide 14. I’ll begin with our U.S. cotton business. The latest addition to that portfolio is Bollgard II XtendFlex cotton in its second year of launch. We expect it to be on about 3 million acres in the U.S. this year, or four times last year’s acres. With strong farmer demand for Bollgard II XtendFlex and our new cotton varieties, we expect to gain three or more brand share points this year, or six points in the last two years. Our vegetable business is also experiencing positive momentum and operational excellence. We’re managing supply well, now boasting the lowest inventory in seven years while delivering nice GP growth exclusive of currency.
In our ag productivity segment, we’re maintaining our emphasis on cost discipline and portfolio optimization. As we near the anticipated bottom of the generic pricing cycle here in the fourth quarter, we expect the pricing comparison for the first half of next fiscal year to be a headwind; however, this should be partially moderated by some expected volume recovery for the full year.
Let’s transition to climate, as shown on Slide 15. Last month, we provided an update that highlighted how we were on track for our targeted penetration of more than 12 million paid acres. That number is now expected to be more than 13 million paid acres for fiscal year ’16. Overall, we are seeing paid offerings up more than 2.5 times versus prior year and now expect to continue that momentum into fiscal year ’17, with targeted penetration of 25 million acres with paid services, nearly doubling this year’s results. It’s clear that farmers are seeing the value that the Climate FieldView platform provides, and that step-up to paid acres builds from the total platform footprint for the technology which is also ahead of target at more than 92 million acres. More than 75% of those platform acres are with growers who are monthly active users of our digital tools.
In addition to strong product penetration results, recent farmer survey results indicate that growers now identify the Climate FieldView platform as the number one digital ag brand in the industry. Global expansion of Climate FieldView is also on track with a pre-launch in Brazil this fall and a launch in eastern Canada in the spring of 2017. Climate has now forged partnerships across more than 10 retail, software and equipment platforms with these relationships serving as yet another strategic differentiator. One of the significant agreements is with John Deere, and we’re on track to launch our in-cab connectivity offering with Deere’s new wireless data server technology for the 2016 fall harvest.
In our other new technology platform, led by our BioAg Alliance with Novozymes, we’re testing microbes this year on a scale that’s unmatched in the industry. At the same time, we are preparing for the launch of our first alliance microbial seed treatment for corn, which demonstrated a greater than four bushel average yield advantage in fiscal year ’15 field trials. This upstream corn inoculant will be marketed under the Acceleron brand in the U.S. and as Jumpstart Xl in remaining geographies. As this product expands to addition crops, it has the potential to penetrate approximately 100 million acres by 2025, making it one of the largest biological products in the ag industry.
Last but not less important is an update on our continued spend discipline, as outlined in Slide 16. Our savings are on track and with lower estimated cost, we’re looking to continue to drive efficiency through the business. We continue to track towards the expected $500 million of savings from our restructuring and cost savings initiatives by fiscal year ’18, reaching an expected $375 million to $420 million by fiscal year ’17.
With that, I’ll hand it over to Hugh.
Thank you, Brett. I’ll focus from here forward on the strategic outlook for our business. I mentioned at the outset that our view of what’s to come hasn’t changed. Despite ongoing industry dynamics and recent challenges, there is one unwavering constant, which is our commitment to an integrated solution strategy that brings seeds, traits, chemistry and data science tools to farmers around the world. We are uniquely placed with our seed position and our digital ag platform with Climate. We believe that this strategy will create tremendous value for society, for farmers, and for our owners as outlined on Slide 17, and the world is going to need it. The long-term demand trends remain robust and are reinforced by the most recent WASDE report. It indicates that year-over-year global demand growth for soybeans and corn continues to be strong, with another billion bushels of corn needed for the year ahead. Beyond that, we see robust demand continuing for decades to come.
The need to help farmers meet that demand through sustainable intensification of agronomic solutions remains a global priority. We continue to see innovation in agriculture as being the answer to satisfy these demand curves, as well as the differentiator in unlocking incremental yield from existing acres. We are best positioned to answer that need. Our leadership in this area is evidenced by the industry’s most proven pipeline, one with up to $25 billion in expected peak net sales and core platforms alone.
By better integrating these technological advances, this approach will allow farmers to maximize yield, minimize risk, improve sustainability, and optimize their overall profit. It’s about selecting the right seeds, traits, and weed, insect and disease control, with accurate data insights so that farmers can manage their operations not just acre by acre by increasing row by row.
It’s our unique innovation platform that underpins our own strong standalone growth plan as well as the industrial logic for Bayer’s proposal to acquire Monsanto, as shown on Slide 18. It starts with our leading seed and trait platform that reaches more than 400 million acres globally and strong and leading germplasm share in corn, soybean, cotton and vegetables globally. We’re the world’s largest seller of seed applied solutions. We’re enhancing our Acceleron seed treatments with plans for a new Phase 4 nematicide, Nemastrike, as well as with microbial treatments developed through our BioAg Alliance with Novozymes. Finally, Climate has emerged as the digital ag platform driven by fundamental competitive advantages. Climate uniquely combines core data and software capabilities, broad commercial reach, and unprecedented adoption, all of which we’ll continue to build as the integrating hub for seeds, traits and chemistries, and that’s clearly recognized by others in our industry.
To further expand the value of this innovation platform, our technology organization has moved forward with unprecedented trials of next-generation technology in the lab and in the field. Overall, this is stacking up to another stellar year with projections of this being the fourth year in a row with more than 20 phase advancements. You’ll get the chance to see our next wave of innovation at Whistlestop on August 17 and 18, so mark your calendars to plan to join us for this event.
To further enhance our unique position to deliver the integrated solution strategy, we’re continually optimizing our portfolio, as shown on Slide 19. As a part of this optimization and further bolstering our position as the partner of choice in innovation, we’ve recently entered several distinct technology agreements. Some contribute directly to the bottom line in fiscal year ’16, and importantly they all contribute to our long-term vision, so let’s take a quick look at some of the most significant agreements.
We just announced that DuPont Pioneer is a new licensee of the Intacta trait stack pending Brazil approvals, which is yet another endorsement of the strength of this rapidly penetrating technology. We exclusively licensed our alfalfa traits and technologies to Forage Genetics International, and we’re in the process of forming a strategic joint venture with Remington Holding Company to more effectively manage our elite sorghum germplasm assets. Both transactions unlock value and create R&D focus while still generating new technologies for our grower customers in a collaborative manner.
We also recently negotiated and signed several gene editing agreements that coupled with our own internally developed proprietary technologies are expected to accelerate and enhance the drive to the next generation of seed and trait solutions. Finally, consistent with our collaborative approach to new chemistry solution development, as shown on Slide 20, we announced a new agreement with Sumitomo Chemical Company to establish future generation weed control trait stacks in several crops. It features a new PPO chemistry paired with the related tolerance gene that not only overcomes weed resistance issues but also controls problematic weeds. Importantly, this new herbicide and trait are being developed in parallel, allowing farmers to access the benefits of this technology earlier than a more traditional sequential development approach. We plan to announce other chemistry collaborations in the near future as we continue to evaluate additional opportunities to drive returns on our innovation and align our portfolio to our integrated solutions vision.
Pierre touched on this earlier, and as I wrap up, I think it bears repeating - our continued commitment to operate as the most innovative company in this space with a foundation of disciplined spend and portfolio management will position us well for the expected rebound in our industry. Many in this industry have theorized on integrated strategies, but we believe we’re the best positioned to make this strategy a reality. With our truly unique asset position in traits, seeds and digital ag, as well as our pace and our breadth of proven innovation, we expect to continue to lead and define integrated solutions for agriculture while continuing to deliver industry-leading ongoing EBITDA margins and return on capital across our peer set, along with strong cash flow to fuel future growth, as shown on Slide 21. Quite simply, this is what makes partnering with Monsanto today such an attractive, unique proposition.
So with that, Laura, let’s move to the Q&A section.
Thank you. With that, we’d now like to open the call for questions. Dr. Rob Fraley, our Chief Technology Officer, has also joined us for today’s Q&A. As we typically do, I’ll ask that you please hold your questions to one per person so that we can take questions from as many people as possible. You’re always welcome to rejoin the queue for a follow-up.
Christine, I think we’re ready to take questions from the line.
Thank you. Our first question comes from the line of Don Carson with Susquehanna. Please proceed with your question.
Thank you. Hugh, a question on your outlook for 2017. Last quarter you talked about a return to rapid growth in ’17, you talked of an earnings snapback. Now, you seem to be downplaying that a bit. I’m just wondering what is it that’s changed in your outlook, because both currency and sort of grain price headwinds seem to be turning in your favor.
Yes Don, thanks for the question. I’ll maybe ask Pierre to categorize or put it in a few buckets, but we’re taking a little bit of a cautious approach until we see how the year plays out. Pierre, maybe if you look at the dissolution of some of these headwinds and then some of the plus points that are emerging?
Yes, and actually entering into 2017, we indeed believe we have momentum, and this momentum will carry us into ’18 and ’19, and we will enjoy a couple of tailwinds definitely. So Intacta traits on 44 to 55 million acres, as Brett mentioned, this is our assumption today and the demand in the market is still very strong, so we see this one as a key driver for growth. We also anticipate Xtend on 15 million acres next year, so that’s also something that will carry us into ’17 with momentum. We also anticipate that some of the headwinds we have this year, we said one--that two-thirds of the headwinds we’ve been seeing this year related to launch of Xtend will disappear, so that’s about $100 million of benefit we are anticipating next year. We also mentioned cost of good momentum in both corn and soy, and there again around $100 million there, and the return to positive pricing in corn.
On top of that, obviously there is the--our assumption right now is we’re not going to be seeing devalution in Argentina comparable to what we’ve seen this year, so these are done, all the positive elements that we see as building momentum entering into ’17.
However, we have to balance those with a couple of other things we are actually watching at this point in time. What we expect is that we will have a tough comparison in glyphosate, mostly in the first part of the year. Our anticipation is that glyphosate pricing is going to stay pretty much where it is right now, and if you look at the first half of fiscal year ’16, we enjoyed pricing way higher than where they are, so we anticipate this one to be a tough comp for us entering into ’17.
The other element that we highlighted today is that from a deal perspective, so this year we have the benefit of $370 million in deals, we are not anticipating at this point in time, based on the portfolio of opportunities we have in front of us, that the deals are going to be of that magnitude next year, and we’ll give a little more clarity on that when we have our operations plans in place. Tax rate will also be a little more challenging next year, based on what we are looking at right now, and we also have to balance the benefit of our restructuring actions with inflationary increases, increased commissions based on the success of our channel model in the U.S. and obviously South America, and also incentives. So if you add to that the impact of India on our cotton business, these are the things we want to clarify, and that’s why as you mentioned, we wanted to be cautious entering into ’17, although as you mentioned we also see a lot of tailwinds there.
So if you put that all together, what would that translate into, sort of high single digit earnings growth, or do you think you can get to double digit earnings growth next year?
So Don, at this point in time we don’t want to give an absolute number at this point in time, and what we mentioned in our prepared remarks is we’ll come back to you as soon as our operational plans are in place.
Okay, thank you.
Our next question comes from the line of PJ Juvekar with Citi. Please proceed with your question.
Yes, hi. Good morning.
You know, if you look at your grower customers in the downturn, they seemed unwilling to pay for the premium seed or sort of innovation, as they seem to have traded down in seed technology this year. So do you think that they’re willing to pay for premium, or the premium pricing only in the upturn and maybe they sort of trade down in the downturn?
PJ, thanks for your question. I’ll maybe ask Brett to say a few words. I think our observation over the last 15 years has been growers need innovation in good years and bad, and the seed that we sell out of first is our best performer. The quantum in that premium changes over those years, but the compromise and reaching for mediocre or average seed doesn’t--that doesn’t play out.
Brett, maybe a few words on the refresh on our portfolio and how we see that in ’17?
Yes, I think--PJ, good morning. If you think about our highest premium product that we sell across the U.S., it’s our SmartStax products, and as we look at this year, SmartStax is going to make up a similar percentage to our overall business as it did last year, so I do not see farmers trading down. We have farmers on the fringes of rootworm areas that may trade down, but it’s not material.
We had to make some adjustments in our pricing ladder that we talked about last year to adjust for the significant pullback in the commodity price, of which now we’re seeing rebound a little bit, and we had to address some of the competitive issues in the marketplace, which we did, I would argue, very effectively and that’s why I’m confident today to say that I actually think for genetic share, we’re up, and for brand share we held our own in the marketplace.
So I feel really good about how we ended up in the U.S. corn business, and when I look to South America, boy, farmers are not slowing down, down there at all. We’re seeing--we took significant price increases in corn last year in Brazil. We’re doing it again this year. Now, granted it’s a currency offset and it’s not offsetting all of it, but farmers are quickly moving to our new Triple Pro in Brazil to get better bug control. So I think even in these challenging times, farmers look for the best seed and the best traits to drive productivity on their farm, and they need it more than ever. I think we see that this year - you know, it’s really disappointing that we ended up with the ongoing delays with the EU, but I have to tell you, farmers were lined up to buy the Xtend technology this year, and I’m really optimistic about that one next year.
So tough conditions do not slow down farmers’ appetite, as Hugh said. They’re looking for ways to drive productivity and profitability.
Thank you, Brett. You mentioned earlier, I think, $150 million of headwind due to delays in Xtend. Is that what mainly contributed to third quarter weakness in soy, or was there something else? Thank you.
So PJ, this is Pierre. It definitely was a big part of the third quarter impact from soybeans. There were a couple of other elements, and the key one is an element of timing. If you remember last year when we entered into the fourth quarter, so at the end of the third quarter, everybody in the market was looking at the soybean market. The expectation was 85 million acres, and the market ended up being 83, so you saw a lot of returns in the third quarter. Right now, people are looking at the market more in the range of 82 million, so this is--also this element of timing, the huge return that happened last year at the end of the fourth quarter, that’s also driving some of the comps when you’re looking at the Q3. But definitely the delay in Xtend from a cost perspective but also from a share perspective has been a big impact for third quarter.
Our next question comes from the line of David Begleiter with Deutsche Bank. Please proceed with your question.
Thank you, good morning.
Good morning, David.
Hugh, how are you and the board balancing the strong rationale for an integrated solutions in ag seeds and chemicals versus potentially selling the company at the bottom of the ag cycle?
Yes, thanks David for the question. As I’m sure you understand, there’s a limit to what I can talk about because these have been private conversations, but let me try and give you a little bit of the landscape to the last piece of your point. I think it is complex because we’re at the low point of the ag cycle, and I think in the tone and some of the comments today, we see some of the early signs of this cycle beginning to turn. As we look at the Bayer proposal and as we examine some of the other strategic alternatives that have emerged, I’m personally engaged in those discussions along with the board, the support of the board and our advisors, and I would say this gets down to two things. It gets down to value and it gets down to certainty, so we’re convinced--the longer this runs, we’re convinced in the value of that integrated strategy. We spent a bit of time talking about it today, and we’re convinced that we have a unique position as an integrator because of our seeds, our unique position in seeds, and the emerging strength of our data science position. So in two short years, I think you’ve seen Climate transition from theory to reality, and I think in the next two years that becomes even more important.
So as we look at the trough, as we look at the Bayer proposal and some of these other strategic alternatives, we are focused, my team and I, we’re focused very, very clearly on creation of shareholder value, and that’s where this begins and it’s where it ends. So we’re going to take a very rational approach to this, bearing in mind where the cycle is and the need for value creation, and we’re going to really focus in the uniqueness of Monsanto and its part as a key integrator.
So I don’t know if that answers your question, but it’s probably the scope of what I can discuss on our call.
No, that’s very helpful, Hugh. Just on the same subject, digital ag, can you discuss maybe further the challenge of getting paid for this platform at is very early, nascent stage of development from other parties?
Yes, so real briefly, our strategy isn’t where it started, but in the early days of working with the Climate team in San Francisco, they were very adamant - and they were right - that this is about driving grower experience, and in the early days it’s about delighting growers and sharing data insights with them. So as Brett talked about 95 million acres up on the platform, the first round of this for us, David, was gaining experience in the same way that all apps are developed, so gaining experience and letting growers work with this on their farms and their fields. The nitrogen advisor has been additional functionality and we have priced for that, and in the last two short years we’ve got all of U.S. retail distribution upon the platform. We’re either in discussion or concluded with all the machinery manufacturers, and I think the next natural step in this is to see some of our competitive companies and some alternate offerings up in that platform as well, so the grower experience--he doesn’t need multiple iPads in the cab.
I think as we move through this progression, then pricing to value and retaining a piece of that value in the same way that we’ve done with traits becomes a natural next step. I think the experience of 15 years of trait development blends beautifully into the next handful of years on data science development and how we broadly license this platform with others.
Thank you very much, Hugh.
Thank you. Thanks for the questions.
Our next question comes from the line of Bob Koort with Goldman Sachs. Please proceed with your question.
Good morning, guys. This is Chris Evans on for Bob. I was hoping you--
Hey Bob, can you--you’re breaking up. Can you get a little bit closer to the phone?
There you go, perfect.
I was hoping you could expand a little bit on the eleventh hour sort of [indecipherable] glyphosate in Europe, so what’s the long term expectation for use of glyphosate in that area? And then if you could also, sort of staying on that topic, talk a little bit about the pricing declines that seem to have outpaced your expectations - you know, what’s the support for pricing?
Yes Bob, I’ll--so thanks for the two elements. I’ll maybe let Rob and Brett talk about this I’d just say before he does, there’s been an element of frustration in this with some of the bureaucracy in the EU, so it’s beyond the eleventh hour but it’s really good to see this finally come through. We’d expected that it would, but it’s nice to see the reality. I think it actually occurred during the call this morning, so Rob, maybe a few words on this.
Well, I think you captured it right. I mean, it’s been a very painful process particularly when you consider that the EU has just completed the re-review of glyphosate and gave it a very strong safety record, and that review was largely led by the German regulators. They took four years, did incredibly detailed review and analysis, and concluded that the product is absolutely safe and has no indication of carcinogenicity. So what we’ve seen play out, unfortunately, over the last six months has been the challenge of operating in the EU system between the parliamentarian votes and the Commission’s final decision, and we--you know, effectively we watched the two teams play volleyball for six months. Today, it was great to see that the Commission moved forward on a science-based decision to extend the product.
So we’re--as Hugh said, the delay has been tough. We’re delighted to have the approval and the extension and are moving forward, and we think that frankly this has been part of the logjam that has delayed our over-the-top Xtend approval. I think the real good news from today’s announcement is I think it accelerates the timing on the approval for the over-the-top application of Xtend.
And then Brett, a word on Bob’s question on pricing?
Yes, as we think about the pricing, Bob, it’s always risky to try to call the bottom on any of these things, but I do believe that we’ve kind of reached that bottom range of glyphosate pricing, and it’s kind of bouncing around there the last few months. I really don’t see anything in the near term that’s going to shift that and move it in a different direction, so it’s purely looking at where we were priced last year in the first half of the year versus where we’re priced right now, and saying that that creates a bit of a headwind for us going into next year that we’ll have to manage against.
I feel good about our position, though, and our cost position and how we’re competing in that industry. We’re down a little bit on volumes this year, but I think that we’re going to recover those back next year as we see the momentum building across the marketplace. So we’re in a good place, it’s just going to be the challenging first half with the price differential between ’16 and ’17.
Got it, thanks guys.
Our next question comes from the line of Christopher Parkinson with Credit Suisse. Please proceed with your question.
Perfect, thank you. Farmer credit’s been a bit of an issue in Brazil, and it’s also been an impediment in other emerging markets - Eastern Europe, India, and at least previously Argentina. When you look at your longer term outlook, how do you think about this in relation to your strategy, how could it affect your growth aspirations? Are there any things we should think about on how you plan on working with growers, distributors, co-ops, et cetera? Just any color on that would be appreciated.
Yes, thanks for the question. I think as you go around the world, every farmer finds themselves in a different position, as do we. If you think about Argentina, for example, we use significant barter for our business down there, so a big chunk of our sales are through the barter system, which minimizes our credit risk with the Argentine farmer. They basically use the grain to buy their inputs.
In the case of Brazil, keep in mind with how currency has impacted our business negatively, it helps put the Brazilian farmer in a pretty good position right now. Buying in local currency and selling in U.S. dollars is not a bad place for them, so we feel reasonably okay. With all the disruption that’s occurred in Brazil in the last year, I’m actually optimistic about Brazil right now with the position of the farmer and their ability to access credit and buy products. Farming looks good, and we’ve got Intacta and we’ve got a strong corn business that’s growing, and we’ve priced up in that environment and it seems to be holding, so we look good in South America.
When you get to Eastern Europe, it’s a mixed deck over there. In the far east, there’s some real challenges, call them geopolitical challenges with the Ukraine. We’ve tended to manage our credit very aggressively - in other words, we don’t extend a lot of credit, and we seem to be doing quite okay over there. That has impacted some of the pricing - some of the farmers have gone to lower priced seed which has impacted our global pricing, but overall we’re in a good place and we continue to be conservative on how we manage the credit.
Perfect. Just very quickly - on your efforts with channel in the U.S. over the last couple years, I imagine the number of seedsmen has grown fairly significantly, but can you just comment on this initiative quickly and the long term, both in terms of the go-to-market strategy, how that’s working, as well as how growers are feeling about the brand’s technology advancement over the last few years? Thank you.
Yes, I think the way we look at it is we like to sell seed the way farmers like to buy seed, and there is clearly farmers that want to buy seed through a direct relationship that we set up with channel. There is farmers that clearly want to buy through retail, which is predominantly our Dekalb Asgrow brands, is selling the seed the way farmers want to buy it. The channel brand has really done well in the last couple of years. We’ve made some substantial improvements, moving it to an agency which created some confusion in our results for a couple of years as we made that transition, but it’s going really well. I have to tell you, some of the other companies out there that are struggling with the performance of their products, the channel brand is a really interesting one for them to consider to become seedsmen for because they get access to the phenomenal pipeline of genetics and traits from Monsanto, and they get to handle a brand that they sell directly to farmers, which in many cases they’ve been used to and that’s the model they came out.
So we feel really good about the multi-brand strategy and how it’s playing out.
Perfect, thank you.
Thank you very much.
Our next question comes from the line of Steve Byrne with Bank of America Merrill Lynch. Please proceed with your question.
Yes, thanks. Let’s just continue down that path a little bit on the channel comment. Brett, you made a comment earlier about your corn genetic share improving this year. Within that, was there a mix shift, say, away from your premium brands, either to the channel brands or to your licensees, and what is the impact of any of that mix shift on price?
Yes, so it’s really early to be that specific between the brands. I’m very comfortable saying I believe that we grew our genetic footprint this year, and yes, there is some strength in some of the licensing business that participates in that. On the brand side, let me be really clear - the channel brand is not an inferior brand to Dekalb. The channel brand is positioned right along with Dekalb, and they both are superior brands targeting to the higher end of performance in the marketplace. There is always shifting between the premium brands in the marketplace - that occurs every year, but I’m comfortable today saying that our direct brand share, we expect it to be flat this year. We’re maintaining our position, so I think when we--when it all settles out in a few months, then we’ll have the details around that, but I feel good with where we’re at.
Steve, the only thing I’d add is the good news is we have created genuine optionality, and you see--to Brett’s point on growers buy and how where they want, they get the opportunity of the licensee route, they have the opportunity at channel or a national brand, and we’ve seen nice migration from some of our competitors because of that. That’s why that genetic footprint has stretched.
The source of your conviction about improvement in corn seed pricing next year, is that driven by mix shift, would you say, or more due to a price lift due to underlying commodity price gain?
So what we are expecting is actually to see a normalized market where the elements of the mix shift are going to be driving our portfolio, and as every year when we issue our price guards, we readjust our price guards based on the commodity price, based on the performance of the hybrid, but definitely--I mean, the key driver is going to be the mix lift that we are anticipating based on the introduction of our new hybrids.
Okay, thank you.
Thank you very much.
Our next question comes from the line of John Roberts with UBS. Please proceed with your question.
Good morning. Can you hear me?
Good morning, John. Yes, we can hear you loud and clear.
I think the EU announced today that they’ve opened an antitrust review of the Bayer combination. I think that’s highly unusual if you don’t actually have a deal yet. I think they normally have a first to file process, but I think they’ve indicated that they would consider any additional deals, possibly holistically in combination with the prior two deals that have been filed. How do we think about the regulatory regime or the approval regime? Is this sort of a one-off environment, or can we rely on kind of past rules and how things have happened in the past?
Yes, I think this must have happened while we were on the call, John. I think it’s more the declaration of intent, rather than they have, so it’s more the intent to do it than they will. My experience with these reviews over the last 15 years is they’ve been pretty logical and pretty straightforward in Europe, but I did talk earlier, a previous question about value uncertainty from a share owner point of view and from a value creation point of view. That’s obviously something that we would treat seriously in any discussions.
So I can’t really say more than that about it, but I think the European declaration was one of intent rather than starting.
Okay, and then given the uncertainty around Round Up in Europe that we’ve had recently, do you think there was channel destocking? I assume it would have affected generics more than you, but I don’t know if you were possibly affected by the supply channel just not wanting to hold as much Round Up inventory during this period of uncertainty.
No, we haven’t seen that. I don’t know what the generic impact has been, but we haven’t seen it with our own brands. I mean, the certainty of today definitely helps, but the reality is weeds grow in the spring and you need to have the material there on hand to control them. So no, we haven’t seen any shift in flow, John.
Okay, thank you.
Thanks for the questions.
Christine, we’ll take questions from one more and then we’ll pass it to Hugh to close it.
Thank you. Our final question will come from the line of Jeff Zekauskas with JP Morgan. Please proceed with your question.
Thanks very much. Hugh, I have a question about value creation at Monsanto. When you consider offers from other parties, and I know you’re limited in what you can say, do you think about the value of the offer relative to where Monsanto might trade in three years or five years in this depressed agricultural environment, or do you have some--or do you and the board have some idea of the intrinsic value of the company that encompasses more favorable agricultural economic climates? How do you--yes, please.
Thank you. I’m sorry I interrupted. Thank you for your question, and this will be the last question. As I indicated earlier, these are private conversations so it’s difficult to comment substantively. But we’re an agricultural business, we are developing technologies on a 10-year horizon. We’ve been in existence for about 15 years, so you can’t--you know, we’ve done many of these calls together over the years. You can’t look at the down cycle in an ag economy - farmers would never farm if they thought about the peaks and troughs, so you have to see through that when you’re either buying a farm or if you’re developing a technology.
So I guess the headline in this is if you’re valuing a unique company like Monsanto, I would argue you can’t look at one quarter. You can’t look at a year - you need to take a 10 or a 20-year view, and that’s how we develop technologies. When you look at the promise of Climate or you look at the value of the pipeline that Rob Fraley and his team have developed, I think you have to take that long view.
We’ve been very clear since May that we were open to these discussions, but that the value had to be reflective of the company and the proposition that we have. The Bayer proposal was financially inadequate. We are looking at that proposal relative to other strategic alternatives, but you have to take the long view in this because the vagaries of the commodity markets are either punishing or they develop elation, but you have to kind of take a line through that. That’s how we’ve always built our resource models, that’s how we’ve always built these products on a seven and a 10-year development cycle, and that’s how we will look at this.
I guess I would finish by saying we are absolutely committed to optimizing share owner value, and we were look at the proposal in hand and we will evaluate these other strategic alternatives against that benchmark. That’s what we need to do.
Thank you so much. That’s very clear.
Thank you for your question. With that, I want to thank you for your patience because we’re a little bit tardy in our finish today. Let me just make two or three points, at the risk of repetition, and it kind of ties to Jeff’s last point on the call.
2016 has been a challenging year for our industry. It’s been a challenging year for the company, but our core businesses have done well but have suffered from some regulatory delays that we’re beginning to see--literally on the call today, we’re beginning to see turn. Despite this, innovation in this industry is needed and it’s recognized by growers, and I think today we’re uniquely placed as a key player in any integrated platform strategy, so regardless of how that integration strategy plays out, we have a central role in that. So as I mentioned on the last question, I’m personally committed to the optimization of shareholder value.
So we’re really pleased that you’re joined us this morning. We are moving forward with preparation for Whistlestop, and we hope to see you there on August 17 and 18. If I was you, I’d be booking a slot soon because those are hot tickets and they’re selling fast.
So with that, thanks very much for the call today and for your continued support.
Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.