FMC Corporation: A Stronger H2 And A Potential Surge In Buybacks Could Propel The Share

Summary

• FMC's geographic and product diversity lends a degree of strength to the operational model and the company's impressive discovery and development pipeline provide significant revenue visibility over the next decade.
• Over the past three months, FMC has underperformed its peers in the material space, but the nature of FMC's current issues is relatively ephemeral.
• There are several tailwinds in H2-21 and FMC will also look to return close to $700m to shareholders in FY21 via buybacks and dividends vs only $343m in FY20.
• The stock is currently trading in line with its long-run valuation averages but there is scope for the multiples to expand even further, at least closer to peak levels seen last December.

Introduction

The Materials sector has recently proven to be one of the shining lights in the investment world; over the past year, its alpha-generating qualities have come to the fore, delivering returns of close to 90% (performance of the flagship materials ETF - XLB), comfortably beating the benchmark index - the S&P 500 (^GSPC).

Source: Yahoo Finance

Within this materials sector, one stock- FMC Corporation (NYSE:FMC), hasn't quite enjoyed the same degree of success and has lagged both its peers and the broader markets, over the past 3 months. As pointed out in the 1-year chart above, FMC had been keeping pace with its material peers for most of the last 12 months (and even outperforming XLB at times), but sometime towards the end of last year, it began to lose steam, and in 2021, we've seen the divergence expand.

In this article, I'd like to focus on the long-term investment case of a company that is one of the top-tier players in an industry that could play a pivotal role in dealing with food security challenges across the globe. I will also touch upon the reasons for the recent underperformance of FMC (although some of this has been made up over the past month), what to look forward to, and then provide some color on the valuations and the price action.

Long-term investment case of the Agricultural Chemicals Industry and FMC

As we chug along in the 21 st century, the smorgasbord of challenges that mankind faces gather pace every day. One of the problems that perhaps does not receive the same attention as environmental disasters, or climate change, is the risk of food security, but it is becoming increasingly clear that this is a risk that is likely to snowball over the next decade or so. In fact, according to the UN World Food Programme, it is estimated that already, an additional 130million people had suffered from acute food insecurity in 2020 alone.

For further clarity, also consider that the global population is expected to hit around 8.5bn by 2030, and the level of food and protein required to cater to the increased population growth will likely grow (the UN believes that by 2050, we will need to increase the current level of food, feed, and fuel by at least 50%). This becomes even more daunting when one considers that 1.5million acres of global agricultural land is being lost annually, and arable land which currently stands at roughly 1/2/acre/person today, will diminish to 1/3/acre/person by 2050.

In light of these challenges, the role of the Global Agricultural Chemicals (AgChem) Industry should not be underestimated, as farmers seek out external solutions to enable them to protect against farm losses, and also chase more yield as they look to produce more crop with the same or less farmland. The Global Agricultural Chemicals market is currently estimated to be worth between $243-$246bn and is expected to grow at over 4% CAGR to hit $300bn by 2024 (FMC management expects the industry to grow at low single digits in 2021). Within this market, FMC is one of the notable global players alongside ChemChina, Bayer AG, Corteva Agriscience, and BASF AG.

FMC- Well diversified operating model with a robust discovery and development pipeline that ensures ample revenue visibility

Several qualities make FMC an attractive pick. Primarily riding on its expertise in Diamide class molecules (Rynaxypyr and Cyaazypr), it has been taking share in the global AgChem market; last year, when the market only grew at low single digits, FMC was able to deliver strong organic growth of 7%. In 2021 too a similar trend is expected, with FMC expecting the market to grow at low single digits whilst they grow at 8% (7% volume growth) (Source: Q4 earnings call).

Source: FMC 10K

One of the most appealing aspects of the FMC story is the geographical diversification of its manufacturing and distribution footprint; it has a presence across Asia, Latin America, North America, and EMEA, and as you can see from the chart above, there is no concentration in any particular region, with all four regions make notable contributions.

This is very handy in an industry of this sort, when weather patterns, natural disasters, and the like, can often disrupt demand conditions and result in significant variations for businesses that are otherwise only exposed to one or a few regions. For instance, agricultural markets based in the Northern hemisphere (North America, Europe, and Asia) generally tend to witness a bump up in activities during March to September, whilst markets in the Southern Hemisphere (Latin America, and parts of Asia Pac including Australia) tend to flourish between July and February.

From a product perspective as well, FMC's expertise across insecticides, herbicides, and fungicides helps in coping with different seasonal patterns; for instance, inordinate rainfall patterns may see a surge in the usage of insecticides or herbicides as farmers seek to negate the risk of increased plant disease or weed growth.

The other impressive facet of FMC is its devotion towards discovering new active ingredients and formulations (FMC currently spends around 6.5% of sales on R&D- Source:10K) which should continue to aid the company's current impressive product base. Even in a difficult year such as 2020, FMC did not cancel any R&D projects but rather chose to phase the projects differently to ensure lower overall costs, in the face of difficult market conditions. Also, in 2020, about $50m of the revenue growth came from product launches in that year itself.

The company's current discovery and development pipeline looks very promising and looks set to ensure substantial revenue visibility over the next decade. Currently, the R&D pipeline includes 11 molecules and biological strains in the "development" pipeline (this could take anywhere between 1-7 years before commercialization) and 25 additional molecules and biological strains in the discovery pipeline (around 8-10 years away from commercialization). As you can see from the image below, over the next decade, FMC intends to launch several new active ingredients and biologicals across various parts of the world, with an estimated revenue contribution of anything between $2bn to $3bn (for some perspective, FMC currently generates about $4.6bn of annual sales). In 2021 alone they plan to launch between 2 to 4 active ingredients.

Source: FMC Investor Technology Update

I also like FMC's thrust in emerging areas such as farm intelligence which will likely gain traction in the years ahead. As part of this initiative, which was only rolled out in 2020, FMC provides an exclusive precision agriculture platform to farmers and agriculturalists to enable them to more accurately pre-empt pest pressures before they actually come to fruition. As of now, through this farm intelligence platform, they've covered about 4million acres across 6 countries. FMC also has useful collaborations with the likes of Novozymes, Zymergen, and Cyclica that enable it to stay ahead of the curve, when it comes to emerging areas of research such as biological enzyme-based crop solutions.

Near-term challenges will be transitory, and H2-21 could prove to be a fruitful period; SAP benefits shouldn't be underestimated

The FMC stock underperformed during the Dec- Feb period due to some challenges in Q4 and its weak guidance in Q1. In Q4, FMC had to deal with various logistics and supply chain constraints in the US, and they also lost out on some business in the lower-value herbicide segment because they didn't want to compromise on pricing. Drought-related delays also impacted their Brazil and Argentinian operations (Source: Q4 earnings call).

In Q1, the company will have to contend with very tough comps in the Latin American region (reported sales were up 26% YoY and organic sales were up 38% YoY in Q1-20). Besides, cotton acreage in Brazil has declined by 15% YoY, there will also be some lingering effects from the drought last year. In the European and UK region, FMC will also have to deal with some revenue attrition on account of discontinued product registrations. We could also see a pickup in R&D costs that were spread out last year and there's also been a pickup in logistics and transportation costs (but this is across the board for all companies).

Going forward, particularly in H2, I expect these risks to dissipate and think FMC could have a particularly fruitful period. Firstly, the revenue attrition in Europe is largely due to timing, with Q1 expected to account for 50% of the entire year's lost sales. The European region is also expected to see a pickup in cereal herbicides by Q3. Secondly, FMC management is also making a very deliberate effort to not replenish their inventory in their Brazilian market because they want to recover the lost pricing seen in 2020 and they think lower inventory could give them an ideal bargaining position to push through higher pricing in H2 and FY22. The weak comps in Q420 should also prove to be very useful for FMC's North American business. Finally, there's also the Indian business which management has talked up for a while now. India grew by a whopping 25% (in organic terms) in Q4 buoyed by demand for rice, pulses, and sugarcane. FMC has also recently undertaken a range of market expansion activities in this region which should aid their prospects. Also do note that traditionally, H2 has almost always been a strong period for the Indian market (the Kharif cropping season will be prevalent from July to October, followed by the Rabi cropping season from October to March).

I'd also pay attention to the cost benefits and efficiencies that FMC could generate on account of the implementation of its new SAP system that went live in Nov-2020; FMC now essentially has a single system across the entire company for the first time in their history and this could translate into significant back-office efficiencies. The company already captured about $50m of savings due to this in 2020 and is expected to get the benefit of another $15m in 2021. Crucially, now that the SAP implementation is wrapped up, there will also be less transformation spending and less pressure on the cash position of the firm.

Pickup in cash distributions to be expected, buybacks to aid the valuation multiple

One aspect of the FMC story that tends to go a little unnoticed is its commitment to shareholder returns. Over the last 10 years, the dividends have grown at 23% CAGR and the ferocity of outflows has picked up even more in recent years with a 3-year CAGR of 48%!

Source: FMC 10K

Understandably, last year, like many other companies FMC sought to be a little conservative with its buyback program and only did about $50m of buybacks compared to $400m and $200m in FY19 and FY20. As of now they still have around $550m of board authorized repurchase gunpowder, and I expect this to gain pace in FY21 as cash outflows towards transformation spend could be substantially lower this year with the completion of the SAP implementation. The increased quantum of buybacks could be very useful in boosting FMC's valuation multiples. All in all, after witnessing a ~44% decline in cash deployment in buybacks and dividends in FY20, the company expects to increase this even beyond the FY19 level and spend about $700m in these two activities in FY21 (management intends to target about $400m-$500m in buybacks and the rest in dividends).

Source: FMC Q4 earnings presentation

Valuations, Price action, and Closing thoughts

To gauge FMC's valuations, I've looked at it from three perspectives, Forward P/S, Forward P/E, and Forward EV/EBITDA, assigning equal weights to all three (~33%). The sales, EPS, and EBITDA estimates in the image below represent the mid-points of the guidance provided by the management in the 10K report.

So, the first thing to be said is that currently, on all three metrics, the stock more or less trades in line with its long-term averages. As per data from YCharts, the stock currently trades at a forward P/S of 2.7x vs the 5-year average of 2.6x, a forward P/E of 13.9x vs the 5-year average of 14.1x, and a forward EV/EBITDA of 12.6x vs the 5-year average of 12.8x. This was not the case a few months ago, in early December when valuations were at their highest point in the last 5 years.

As I've highlighted in the sections above, FMC has a lot of impressive qualities that will hold it in good stead over the long term, but it is currently just going through a slightly difficult patch and has consequently seen a slight drop-off in valuations towards the historical average (In Feb it had dropped to levels below the historical average).

Given the inherently fleeting nature of FMC's current challenges, I expect H2-20 to be a more fruitful period and believe that the stock has the potential to return back to the valuation levels seen in Dec (with the potential for this to expand even further). Also, consider the likely pick up in the run rate of buybacks which also has the potential to boost the valuation multiples.

Thus, in the table below, I have assigned the peak 5-year cycle multiples last seen in December 2020 to determine the respective targets as per P/S, P/E, and EV/EBITDA. I acknowledge that the EV/EBITDA-based target of $135 may come across as a tad aggressive, but this is mainly due to the heightened level of cash on the balance sheet. FMC management did confirm that they deliberately boosted the cash level in Q4-20 to prepare for potential working capital build in H1-21, so in all likelihood we may see lower cash vis-à-vis current levels, potentially bringing down the equity value and the target price.

But to mitigate this, also note that I've used the FY20 weighted average diluted shares figure of 130.5 (and not a forecasted number). Going forward, it looks all but certain that this figure will dip even further by more than 1% (share count was down by ~1.1% in FY20 vs ~3% in FY19), as I expect the level of buyback to be more in FY21 than in FY20. This too could boost the target price although it has not been accounted for in my calculations. In effect, the weighted average target price works out to $124 which represents around ~9% upside from current levels. Note that I've only gone with the mid-point of the guidance and there's potential for FMC to have a strong H2 and meet the high point of its guidance. If one were to take the high point of the guidance across sales, EPS, and EBITDA, the weighted average target price would work out to $129, or ~13% returns.

Source: Prepared by the author using data from YCharts and FMC's 10K Report

FMC's price action in the recent past has been hard to ascertain, and this is reflected in the relative congregation of the 3 key moving averages on the daily chart (50, 100, and 200 DMA,) which broadly reflects indecision amongst market participants. In addition to that, the 3 moving averages are not in harmony, i.e. 50DMA > 100DMA > 200DMA for long positions, or 50DMA < 100DMA <200DMA for short positions.

Source: Trading View

Shifting the lens to the larger time frame (the monthly chart) we can see the price action since 2016 has transpired in the form of an ascending channel and the stock is now caught up in a congestion wave since August-20 (the green highlighted zone), and has been unable to break and close past the upper boundary of the channel.

Source: Trading View

Perhaps this article is a month late, as an entry at around the Feb 2020 lows would have served as a very attractive entry point, as it would have coincided with strong support at the psychological barrier of $100-$101. From there until the target of $124 which also coincides with the previous high seen in Dec-2020, you'd be looking at about 24% returns. At the current price levels, the return-generating prospects don't look as attractive as a few months back but I reckon we could see a retest of the previous high around the $124 levels; conservative investors can consider getting out here; aggressive investors who have more confidence in FMC's H2-21 performance (implying the potential to meet the high-end of the FY21 guidance) and the support of increased buybacks can hold out to the $129-$130 levels before considering an exit.

Analyst’s 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.