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Published: June 8, 2010
During the past two years, only one
non-financial services stock has lost more than $50 billion in
value. This one-time highflyer made mistake after mistake, and
has seen
market capitalization drop in value from $77 billion to
$27 billion.
I'm talking about Monsanto (NYSE: MON), and I'm talking about it
now because the shares are showing fresh signs of life in recent
sessions. When a stock can hold its own in this market,
investors often see solid gains once the broader market
stabilizes.
Thanks to massive spending on Research & Development (R&D),
Monsanto was able to become the leading player in the nexus of
biotechnology and agriculture. Its patent-protected seeds helped
farmers boost yields -- and carried great profit margins. Its
Round-Up herbicide also proved to be a cost-effective way to
keep weeds in check, saving farmers money while sharply boosting
cash flow -- a win-win for everyone.
Then the wheels fell off. First, Chinese chemical companies
started to steal major
market share from Round-Up through a
low-priced generic version called glyphosate. Then rivals, such
as DuPont's (NYSE: DD) Pioneer Hi-Bred division started to close
the technology gap on those yield-boosting seeds. As a final
straw, farmers began complaining that Monsanto was unfairly
restricting their ability to use other cheaper seeds in tandem
with its proprietary seeds.
As a result, management has been in damage control mode since
last fall. It loosened the company's seed policy, sharply cut
prices for Round-Up, and most important, changed the profit
dynamic between itself and customers. In the past, Monsanto
priced its seeds to be sure that the profits farmers made by
using the seeds were roughly equivalent to what Monsanto was
making on its sales. Now, in a bid to burnish its reputation,
prices have been re-set to give farmers two-thirds of the
profits.
Management believes that diminished profit margins will more
than be offset by higher demand. That's because the company
expects to take back market share from rivals Pioneer Hi-Bred
and Syngenta (NYSE: SYT), whose seeds don't offer the same
degree of insect and weed resistance, but carried lower prices.
Life Left for Roundup
Monsanto's recent decision to slash guidance was also largely a
function of sharp price reductions for Roundup. You can bet
management hated doing so. The company generated nearly $2
billion in profits from Roundup in fiscal 2008 by pricing it at
$20 a gallon. But in recent quarters, Chinese rivals sold the
generic version for half that price. Monsanto recently announced
that Roundup will be sold for just $8 a gallon and will only
make about $1 in profit on each gallon sold, or about $250
million annually.
Strangely, Monsanto
is the industry's
lowest-cost producer
thanks to its
backward integration
into phosphorous
production, so such
thin margins on the
lower price have led
many to suspect that
Chinese rivals have
been selling the
generic version at a
loss. Indeed, 50 of
the 65 Chinese
producers have
already exited the
market, and a
further shakeout is
expected. Reduced
competition could
enable Monsanto to
push Roundup prices
up $1 or $2 later
this year. Each $1
swing in the price
equates to $250
million in cash
flow.
GM -- Round
Two
Monsanto virtually
invented the GM
(genetically
modified) seed
market, but as
noted, has recently
seen its rivals play
catch up. But it's
important to note
that the company's
seeds remain
superior by a
variety of measures.
Monsanto only lost
market share from
overly-aggressive
pricing strategies.
The recent price
cuts to rebuild
market share are
another factor
behind recently
lowered guidance.
Yet management also
notes that the
technology roadmap
during the next few
years remains quite
robust. That's what
$1 billion in annual
R&D spending can do.
Starting with an
analyst meeting
slated for
mid-August, Monsanto
is expected to begin
discussing new
product rollouts.
Right now, analysts
have little
information with
which to formulate
future growth
projections.
Action to Take
-->
Monsanto sought to
lower the bar so
sharply in May that
the next time the
company had to
change guidance, it
would be up rather
than down. Indeed
the cycle of
downward earnings
revisions appear
over. Up until 18
months ago,
management
consistently sought
to keep expectations
low and then shoot
past forecasts when
results actually
came out.
A combination of
tremendous
intellectual
property, a
still-robust global
agricultural
picture, and a more
farmer-friendly
attitude should push
this company back on
the growth path.
Shares traded at
more than 40 times
projected profits a
few years ago, but
now trade for about
16 times projected
fiscal 2011 profits.
This stock will
never again garner
such a rich
multiple, but
there's no reason it
can't support a P/E
ratio in the low to
mid 20s. That would
translate into about
+50% upside back to
around $75. That's a
far cry from the
$150 levels seen
back in 2008, but
new investors in the
stock won't complain
about such a gain.
-- David Sterman
Staff Writer
StreetAuthority |
