As Warren Buffett, George Soros and so many others have said,
you need to swim against the tide, finding values where others miss
and shunning stocks that are loved by all.
Back in the summer of 2010, agriculture firm
Monsanto (
MON
)
was simply loathed. Low-cost Chinese competitors were eating into
its Round-Up herbicide franchise, farmers were up in arms over a
restrictive seed usage policy (which made its way to a story on 60
Minutes), the company was headed for a 10% drop in annual sales and
analysts were uniformly tepid on the stock's prospects.
As I noted
back then
, Monsanto's $1 billion in annual research and development spending
would soon make the company relevant once again. Indeed, in the
subsequent
fiscal year
(ended August 2011), Monsanto's sales rose 13% to $11.8 billion and
earnings per share (EPS)
shot up a heady 49% to $2.96.
Yet as you dig into just-released quarterly results and start to
look at where Monsanto may be headed next, you may find reasons to
sell. The stock's impressive rebound has set up a clear disconnect
between a fairly high valuation and slowing growth. That's what
happened to major drug stocks a decade ago and may be happening to
Monsanto soon.
Another good quarter
Monsanto just announced fiscal second-quarter results that once
again topped forecasts, this time with an
EPS
of $2.28 (roughly 7% ahead of projections). Almost all of the
upside was attributed to stronger-than-expected demand for corn
seeds, as farmers got an early start thanks to very balmy weather
this winter. Some of that strength may also extend into the current
quarter as spring plantings are underway, but many analysts decided
to leave their full-year forecasts intact.
The pull-in for the planting season is expected draw demand from
the summer quarter. Despite beating second-quarter estimates by
$0.16, analysts have boosted their fiscal (August) 2012 full-year
estimates by just three cents to $3.54.
It's the view beyond 2012 that becomes more concerning. The company
is now so large, and the field so saturated, that unless Monsanto
can take
market share
from
Syngenta (
SYT
)
,
DuPont's (
DD
)
Pioneer Hi-Bred division or other emerging global rivals, then
investors need to brace for slowing growth. The company has likely
squeezed out all it can from the "ethanol play" --
ethanol-as-a-fuel mandates, which led to major corn planting, are
set to expire in coming years.
After a good 20% growth in fiscal 2012, analysts at UBS, which
rates the stock as a "neutral," recently wrote that "we expect only
13% growth in F13, then we expect less than 10% growth in F14."
It's important to note that after a strong two-year run,
shares
of Monsanto now trade for more than 20 times
forward earnings
. Recall that major drug companies finally stopped growing as their
drug pipelines matured and new drugs failed to outpace older drugs
that lost patent protection. Will that multiple compress, as UBS
suggests, until Monsanto looks more like
Merck (
MRK
)
or
Pfizer (
PFE
)
?
.png)
With the exception of 2009 and 2010, when Merck completed a pair
of large acquisitions, sales have not grown more than 5% at any
point in the last decade. EPS in 2011 was roughly 30% lower than it
was a decade ago. As a result, Merck's stock started to garner an
ever-lower price-to-earnings (P/E) ratio.
There's one clear connection between Monsanto and Merck: Each once
spoke of a blockbuster product or two that could fuel tremendous
growth, but each eventually has come to rely on a series of smaller
hits to keep that ball rolling. As UBS' Andrew Cash recently noted,
Monsanto's
CEO
is "increasingly spending more time discussing its multiple sources
of future
earnings
, including integrated farming systems, and almost no time on new
blockbuster product introductions. We believe this is code for
slowing overall EPS."
You can see that slowing growth by walking through updated
projections provided by Merrill Lynch. After boosting
EBITDA
22% (to $3.05 billion) in 2011, they see EBITDA rising 19% this
year, 11% in fiscal 2013 and 5% in fiscal 2014.
When "neutral" is a "sell"
Here's the tricky thing: Nobody on
Wall Street
will tell you this stock is going to go down.
Indeed, this is a stock that has made
bullish
analysts look smart in front of their clients, and they need a
reason to keep getting in front of those clients if they are to
secure a meeting at all. Sadly, that's what more than 10 years of
working on Wall Street taught me.
[block:block=16]UBS, in laying out its concerns, only has a
"neutral" rating, lest the firm's analysts end up in the doghouse
with Monsanto's management. Goldman Sachs also recently lost its
appetite for this stock, removing it from the firm's "Conviction
List." But they still suggest the stock deserves to trade at 20
times projected fiscal 2013 EPS of $4.38. Yet as noted earlier,
slowing growth more likely argues for a slowly falling multiple.
Monsanto's projected rates of growth are unlikely to support an EPS
(and thus, a P/E ratio) that high.
Risks to Consider:
Monsanto still spends huge sums on R&D, and those efforts
may still
yield
another blockbuster product to bolster future sales.
Action to Take -->
Note the phrase "slowly-falling multiple." There's no reason to
expect this stock to fall out of bed quickly, but it appears to
have peaked after a solid two-year run. A high multiple and slowing
growth is never the recipe for further upside.
If you own shares, then this looks like a good time to sell. And if
the
market
rebounds and brings this stock back into the $80s, then it would
only strengthen the case to short this stock.
[
Note:
If you haven't heard about this unique opportunity, then I want to
tell you about it now. StreetAuthority has staked me with $100,000
of real money to invest in my absolute best ideas. For a limited
time, you'll be able to follow along with me completely free.
Go here to learn more
.]
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.