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
, 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
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
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
, 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
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
Disclosure: David Sterman does not own shares of any security
mentioned in this article.
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