Corteva Will Keep Rising
- Corteva was underpriced by the market.
- Corteva will beat EPS estimates in 2021.
- Cost reduction and share buybacks have not been accounted for in the market pricing, yet.
Corteva’s (NYSE:CTVA) share prices are up 86% in the past one year. Slowly, yet steadily, the share price keeps rising. But why? The revenue, net income or even the cash flow have not changed significantly enough in comparison to its past performance to justify the price rise. Additionally, my previous article showed how Corteva is losing its market share in the corn seed industry. I will explore two hypotheses to find the cause. 1. The share prices are converging towards their fair value. 2. Corteva is always beating expectations.
Convergence to fair value
It is possible that the market has mispriced Corteva from the beginning, possibly due to the poor financial performance it has shown in the previous quarters. A back-of-the-envelope cash-flow-based valuation assuming management’s cash flow expectation about 2021 leads to a valuation of $60.72/share. Management has given guidance of $3B-$3.5B of cash flow from operations (CFO) for 2021. The valuation with $3B of cash flow results in $48.6/share.
Source: Prepared by author using SEC filings
Ignoring the period of drop and recovery in share prices due to the pandemic, Corteva shares’ real rise began after Q3 2020 results were announced. This was not by accident. Rather it was because of the inherent cyclicality in the agriculture industry. The cyclicality is Q3<Q4<Q1<Q2, meaning the revenues generated in Q3 are the lowest for the whole year and Q2 sees the highest revenue generation with a steady increase from Q3 of previous year to Q2 of the next. This steady rise in revenue driven by the agriculture sector, the recovery momentum from the pandemic dip and confirmation of financial performance of Corteva independent of its parent organization has been driving the share prices till now.
But the release of Q1 2021 earnings opens the Pandora's box of secrets. In previous earnings calls, the management has said multiple times regarding the benefits Corteva will reap from the 4-year Dow Cost Synergy program designed to integrate and optimize the organization following the merger and in preparation for the business separations. The actions taken by the company were primarily to reduce operational expenditure by removing low margin production sites, streamlining workforce, de-centralizing packaging (bring inventory closer to sales site to avoid currency translation losses) and removing external dependency.
Source: Q3 Presentation
From the latest results, at least we can see a good progress in streamlining workforce. Although management has declared that expenses related to the program are substantially completed, I was surprised to see that restructuring and amortization of tangibles represent an even higher percentage of revenue today in comparison to Q1 2020. In any case the reduction in operating expenditure is around 1.39% of revenue. I agree that it is not much and could very well be considered as coming under the QoQ volatility of OpEx. However, the important point to note is that Corteva has achieved a higher operating efficiency with higher revenue (+5.6% QoQ). Lower operating expenditure and higher revenue are all good indicators of improving profit margins in the near future.
Source: Quarterly filings
Analyzing any earnings statement, without taking into consideration the effects of the pandemic would be a mistake. Yes, Corteva is facing problems due to the pandemic, especially in international transport, and there is no certainty of when its transportation problems will sort out. However, the silver lining is the de-centralizing of the packaging and bringing the products closer to sales sites. Initially, as per the management, this action was taken to prevent losses due to currency exchange. However, I believe that if the packaging is de-centralized and stocks of products are kept near the site of sales, then even transportation challenges will not greatly affect the bottom line of Corteva. Increased FY 2021 guidance, reducing operating expenditure and inherently underpriced shares indicate that the convergence to fair value will continue in the near future.
21 analysts have a consensus estimate of $1.93/share (Low:$1.75, High:$2.06) for a revenue of $14.68 B for 2021, which are very low based on the guidance provided by the management and the operational efficiency shown by Corteva in Q1 2021.
Source: Prepared by author using data from Q1 2021 earnings presentation
Even considering that expenditures such as restructuring and amortization of tangibles shall continue for the complete year, Corteva should beat consensus estimates by a healthy margin. In addition, Corteva has an ace up its sleeve as well. As reported in its 2020 annual report, it has $700M available for use for share buybacks that they earmarked in June 2019. In their Q4 earnings call Jim Collins, CEO, said:
On capital allocation, you may recall that we discussed last quarter that we planned to accelerate the completion of our $1 billion share repurchase program by the end of 2021, which was six months ahead of our initial plan. Given our current cash position and outlook for 2021, we expect to complete most of the repurchases by midyear while maintaining our strong balance sheet and investing for growth.
Clearly those funds have not been used as the weighted average number of shares still remain at 744 M. At the current market price of $50, $700 M will reduce 14 M shares from the market.
Positive surprises in earnings are generally greeted with good upswing in the stocks (can’t say that about Corteva after today’s drop) and it is a well-known fact that in the short term, expectations rather than performance drive the share prices in the market. When expectations from the company are so low and it beats the consensus EPS consistently, it is sure to attract attention. Another reason that will provide the support for the upside in Corteva’s shares will be lower consensus expectations resulting in consistently beating the estimates. As mentioned before, this is a short-term push and cannot sustain for more than 2 quarters. Prevailing agriculture industry conditions, federal decisions and commodity prices can quickly swing the market consensus to levels that Corteva will not be able to beat consistently.
Corteva is a financially strong company with steady revenues and strong cash flow generation. Although I believe that it is losing market share, I am positive that the bullish run on its share prices will continue because of two reasons. Firstly, the market has underpriced the share since its separation because it had no idea on how the company would perform independent of its parent organization. In 2020, it proved that it can continue to deliver the same performance as it was delivering as part of a conglomerate. It is confirmed that Corteva has taken concrete steps that has resulted in reduction of its operating expenditure. As per the latest cash flow guidance (provided during Q4 presentation) by the management for 2021, the fair value of Corteva is $60.7/share. Secondly, consensus estimates for Corteva are very low. In the short term, consistently beating consensus estimates has a psychological effect on the market participants about the future growth of the company. That accompanied with possible share buybacks worth $700 M tells me that irrespective of the financial performance growth, Corteva will beat market expectations. The market expects higher margins, higher revenue and financial proof that their synergy program has converted to dollar savings. However, Corteva is running out of time to deliver. After Q2 2021 results are announced, the agriculture cycle will be over. Revenues will drop, efficiency will degrade and it will not be until Q1 2022 that management will get a chance to prove their efforts. I am long in Corteva because I believe that it has shown me enough evidence that its revenues and expenses are moving in the right direction and being a value long-term investor, I am not much worried about the short-term volatility of the shares.
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Analyst’s Disclosure: I am/we are long CTVA. 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.
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