Corteva: Relatively Cheap Valuation, Double-Digit Pro Forma Operating EBITDA Growth

Dec. 06, 2019 4:37 AM ETCorteva, Inc. (CTVA)9 Comments9 Likes
Vasily Zyryanov profile picture
Vasily Zyryanov
1.63K Followers

Summary

  • Corteva was spun-off from DowDuPont in June 2019. Since then, despite a short-lived rally, the stock has lost ~14%.
  • Its 9M 2019 financial performance was imperfect, as net income and cash flow were negative, while sales were down 2%.
  • The management has ambitious medium-term goals like 12-16% operating EBITDA growth in 2020-2022.
  • Corteva is not generously valued at only ~9.4x EV/2020E operating EBITDA.

Corteva, Inc. (NYSE:CTVA), a newly born agricultural chemicals and seed company that was spun off from DowDuPont in June 2019, has lost around 14% of its market value since then, as Q2 and Q3 results disenchanted investors. Now the share trades at only $24.82. Upon cursory inspection, the stock is imperfectly priced as its market value of equity is ~30% below its net worth.

Still, current financial performance impacted by a few issues like the trade war repercussions, FX headwinds, a swine fever in Africa, and weather in North America (that led to delayed planting) is imperfect; for instance, Corteva has negative margins (except for gross profit margin) together with negative operating cash flow, let alone FCF. That might partly justify the mediocre valuation.

However, the management anticipates noticeable improvement of operations in 2020, while analysts forecast double-digit earnings growth in the medium term. Also, recent insider purchases hint the stock deserves a more profound assessment.

The top line

To rewind, this year, to enhance shareholder value creation, DowDuPont was split into three companies: Dow (DOW), DuPont de Nemours (DD), and Corteva. After the separation of the latter, on June 1, DowDuPont Inc. changed its registered name to DuPont de Nemours, Inc. The rationale behind the spin-off of Corteva was to aggregate E. I. du Pont de Nemours' Pioneer and Crop Protection businesses and Dow AgroSciences ("DAS") to leverage their enhanced strengths. E. I. du Pont de Nemours (abbreviated as EID) is the official predecessor of CTVA.

Corteva has two reportable segments: Seed and Crop Protection. The company's portfolio encompasses germplasm, traits (for corn, soybean, and sunflower seed markets), insecticides, herbicides, fungicides, and numerous digital solutions. This gives it some sort of flexibility in case one segment underperforms drastically pummeled by specific headwinds. Also, it has a vast and diverse customer base in four key regions: North America, Latin America, EMEA, and the Asia Pacific. According to the company's data (see page 6 of the presentation), the market share is the strongest in North America, as it is responsible for $7.4 billion of seeds and crop protection sales, while the total market in the region is around $27 billion.

It is tough to be bearish on agriculture in the long term. The United Nations anticipates the global population will increase by two billion persons by 2050, and it is quite apparent that the growing population needs food, and agricultural producers will inevitably flourish in the future because of this simple and clear trend. So, to keep pace with the irrevocable tendency, the agribusiness will have to evolve, adapt, and transform. At the same time, companies like Corteva that provide germplasm and chemicals for seed, crop protection, and yield maximization, together with cutting-edge technical solutions (like LANDvisor), will enjoy gradual revenue and cash flow growth respectively.

A deeper look at valuation

At the moment, the company's operating performance is far from stellar, as this year it has been impacted by the tariff confrontation, currency devaluation (of Brazilian Real primarily), weather that delayed planting season in the U.S., and African swine fever. For instance, 3Q reported sales of $1.91 billion were down 2% compared to 3Q 2018, while pro forma operating EBITDA rose 18%, but still was sub-zero.

What immediately arrested my attention was negative net operating cash flow, let alone levered free cash flow; in 9M 2019, its cash flow was -$2.3 billion. Negative CFFO is far worse than sub-zero accounting profit, as sometimes net income does not reflect actual cash inflows and outflows of a company and could be easily distorted by accruals, one-off items, etc.

It is worth highlighting that negative net CFFO despite higher net earnings is an issue Corteva's closest peer FMC (FMC) had to address in the last four quarters.

ChartData by YCharts

The main culprit was working capital that, in turn, was affected by inventory build-up and reduction in advance payments from customers. CTVA's case is precisely the same, as it had a negative $3.7 billion net change in operating assets and liabilities. The working capital fluctuations, in turn, depend on the seasonality of the business, and will likely normalize in 2020; so, the problem is not so deep as it seems to be at first sight in both cases of FMC and CTVA.

While cash flow is sub-zero, other metrics like net income and EBIT are also negative. So, by now, we cannot value it using either widely used adjusted or GAAP earnings yield and EV/EBITDA, nor less popular FCF yield and other cash flow metrics. However, the company has a non-GAAP measure known as pro forma operating EBITDA (which is, but briefly, an adjusted EBITDA; see page 39 of the presentation for clarification), which, according to the guidance (see page 23), this year might reach ~$1.9 billion.

So, with Enterprise Value of ~$20 billion, it deals at ~10.5x EV/2019 EBITDA. This translates into the 2019 EBITDA-based Return on Total Capital of ~6.5%. The company also assured in 2020-2022 pro forma operating EBITDA could go up 12-16% YoY spurred by cost synergies and productivity programs. Hence, its Forward EV/Adjusted EBITDA is approximately 9.1x-9.4x. For broader context, FMC trades at 11.7x trailing twelve months EV/EBITDA and 13x Forward EV/EBITDA with EBITDA-based ROTC of 21.6%.

Besides, Corteva sees material free cash flow generation going forward. The firm targets to convert more than 50% of operating EBITDA into FCF in 2020, or around $1 billion. So, the firm is trading at ~5.8% Forward FCF yield.

Now let's look more attentively at issues that made the statement of operations so distressed in 9M 2019. First, sizeable integration and separation costs of $694 million (6.3% of revenue) have taken a toll on operating margin. These costs were one-off in nature and, thankfully, will not impact operating profitability in the coming years. Another matter that arrested my attention was hefty Selling, General & Administrative expenses that consumed 21.3% of net sales in 9M 2019. R&D activities also required hefty funds, 7.8% of revenue. By contrast, its closest peer FMC Corporation (FMC) used only 16.7% of revenue to cover SG&A and just 6% to finance R&D initiatives.

Price/Book requires adjustments

After all, I should take a more profound look at the Price/Book ratio, which currently stands at 0.7x, indicating the company is obviously underappreciated and misunderstood by the market. Among the reasons why P/B is so low is a diminutive debt of the company mostly comprised of short-term borrowings and finance lease obligations, which now equals only $3.71 billion, while cash & cash equivalents together with marketable securities cover 57% of it.

However, if we take a closer look at the total assets of Corteva, we will immediately notice that Goodwill and Other intangible assets (like developed technology) account for more than 50% of total assets and 75% of long-term assets.

CTVA long-term assets. Data from Q3 2019 Form 10-QCorteva's long-term assets. Author's creation. Data from Form 10-Q

Adjusted for intangibles, Price/Tangible Book Value equals 3.7x, which does not look that cheap. Uncoincidentally, FMC has a similar balance sheet constitution with a substantial amount of intangibles and goodwill (72% of long-term assets).

FMC long-term assets. Source: Form 10-Q FMC's long-term assets. Author's creation. Data from Form 10-Q.

But the peer is trading at 4.7x P/B, which might be explained by its capital structure. FMC's Debt/Equity is approaching 134%, so, shareholders' equity is impacted by debt burden. At the same time, after certain adjustments, P/B translates into a Price/Tangible Book Value of 17.3x, which looks quite expensive.

I would not say the companies are overvalued only because inflated P/TBV, but readers still should bear in mind that the bulk of their assets are intangible (technologies, trademarks, etc.).

Dividend

At the moment, CTVA yields ~2%. The issue worth highlighting is that now shareholder rewards are covered neither by net income nor by operating cash flow, let alone free cash flow. The company finances it using the massive cash pile on its balance sheet, which, however, is gradually wearing out. However, that is expected to change in 2020.

ChartData by YCharts

Speaking about shareholder rewards policy, as it was mentioned in the Investor Day presentation (May 2019), Corteva targets to return 25-35% of net income to shareholders "with increases over time with earnings and free cash flow growth." So, as analysts anticipate 2021 EPS to equal $1.88, the annual DPS might creep higher to $0.658, specifying a ~2.6% yield, which still does not look appealing, at least for my taste.

Final thoughts

In sum, after more in-depth inspection, Corteva looks slightly undervalued despite its high operating EBITDA and EPS growth prospects. While its current financial performance is far from flawless, I see no fundamental reasons that could hinder it from reaching medium-term sales, EBITDA, and FCF targets. Still, the inability to live up to expectations because of external headwinds or any other issues will inevitably take a toll on the market value of equity.

At the moment, analysts anticipate its revenue to grow with a low'single-digit rate from 2019 to 2022, while their earnings estimations are much more optimistic. Wall Street considers Corteva is capable of delivering double-digit EPS growth from 2019 to 2022. So, assuming CTVA will be able to live up to their expectations, its share price will inevitably be propelled by earnings growth.

I suppose its ambitious medium-term financial targets are doable, as the company has a pipeline of product launches through 2023 designed to cement and expand its market share. In November, insider buying accelerated, likely indicating executives see material upside potential after the recent price drop. To conclude, the bulk of Wall Street pundits who cover the stock have a neutral sentiment, but I am cautiously bullish on the stock.

This article was written by

Vasily Zyryanov profile picture
1.63K Followers
Vasily Zyryanov is an individual investor and writer.He uses various techniques to find both relatively underpriced equities with strong upside potential and relatively overappreciated companies that have inflated valuation for a reason.In his research, he pays much attention to the energy sector (oil & gas supermajors, mid-cap, and small-cap exploration & production companies, the oilfield services firms), while he also covers a plethora of other industries from mining and chemicals to luxury bellwethers.He firmly believes that apart from simple profit and sales analysis, a meticulous investor must assess Free Cash Flow and Return on Capital to gain deeper insights and avoid sophomoric conclusions.While he favors underappreciated and misunderstood equities, he also acknowledges that some growth stocks do deserve their premium valuation, and its an investor's primary goal to delve deeper and uncover if the market's current opinion is correct or not.
Follow

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.