Monsanto – A Round-Up of Opportunities

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

March 14th, 2016

Monsanto – A Round-Up of Opportunities

  • The bull case for Monsanto relies on assumptions around three key dimensions:
  1. The Ag Cycle
    • It is evident that depressed prices for agricultural commodities have crimped farm incomes; far less evident is when the cycle will turn
    • Predicting the turn in the ag cycle is beyond our purview – too many variables to make much more than an educated guess
    • Timing appears opportune, however, for contrarian investors to purchase the industry’s technology trailblazer given that it is hard to see how things get much worse for much longer amidst the trend of consolidation
    • Growth in global food demand remains a powerful trend of multi-decade duration, despite near term concerns that yield growth has raised productivity faster than demand
  2. Consolidation
    • Perhaps taking the view that the extended ag downturn has a secular component, the industry has reacted with a series of major deals
    • MON has, as yet, been the odd man out in these dealings – despite first mover efforts
    • Risk is overpaying to get in on the action – partnerships/JVs mitigate this risk and MON has indicated openness to this approach
    • Consolidation on its own should improve industry-wide fundamentals and bolster pricing
  3. Valuation
    • Risk/reward sets up nicely: ~20% downside to $72 per share (applying a 16.5x multiple to the low end of 2016 guidance) versus greater than 40% upside to at least $130 per share (applying an 18.5x multiple to 2019 EPS of $7.20, a $0.60 haircut to current consensus)
    • Modest negative revisions may continue to trickle in but MON recently reset guidance and FY ’16 estimates have already come down 26% over the past half year
    • Longer term EPS estimates reflect strong growth that is not appropriately discounted in the stock price
    • Debt is not a major concern – representing only 12% of enterprise value and just 1.7x trailing EBITDA – though $1.2 billion is coming due over the next two years ($700 M in 2016 and another $500 M in 2017)

Exhibit 1

Source: Capital IQ and SSR Analysis

Overview

Monsanto presents an intriguing investment case – a contrarian opportunity to buy the market leader in a technology-driven, important industry at a time when there are cyclical headwinds and other pressures. The company is facing a number of serious company-specific and macro challenges that are affecting its bottom line and 2016 earnings estimates have been reduced 26% in the past six months. Despite the prospect for down earnings this year, the company points to its ability to grow EPS at a mid-teens clip for several years going forward through a combination of innovative new product introductions, cost efforts and effective capital deployment. Some quick math using the mid-points of Monsanto’s March 2 news release suggests an EPS target of over $7.20 in 2019. That would likely be valued at a high teens multiple leading to a stock price of around $130. Even discounting that target back for 2-3 years at 10% leads to a current fair value of $102, upside of 12%. That’s without any help from an improving farm economy. If corn and soybean prices get caught up in a commodity price bounce similar to what’s been happening in oil and metals over the past few weeks a move can happen quickly. Finally, there’s the possibility of Monsanto participating in a value-creating deal at a time when everybody in the industry seems to be talking.

Below we discuss the relevant dimensions to the MON bull thesis as outlined above.

  1. Ag Cycle

Recovery Timing is Always Uncertain but Pricing is in Line with Prior Trough

It is foolish to try and predict the timing of a turn in a commodity cycle with any precision. What we can say though is that cycles come and go and at current levels, agricultural commodity prices have already fallen substantially. While this doesn’t rule out the possibility of further declines, corn prices are down over 50% since the middle of 2012 and sit at levels last seen during 2009’s financial crisis (although they are still higher than troughs in the pre-ethanol days) – Exhibit 2. Lower prices plant the seeds (pun intended) for better future outcomes as farmers, on the margin, adjust planting acreage and/or if yields are negatively affected by any number of variables including poor weather or heavy infestation. February’s USDA’s World Agricultural Supply and Demand Estimates (WASDE) report forecast 2015/16 corn plantings of 88 million acres of corn, down 3% year over year and representing the third consecutive year of planted acreage declines – Exhibit 3. The last time U.S. corn plantings fell three years in a row was 1977 through 1979.

Exhibit 2

Source: Capital IQ, WASDE and SSR Analysis

Exhibit 3

Source: WASDE and SSR Analysis

Long-term Secular Drivers in Tact and Intacta

Despite the current headwinds, the longer-term drivers for Monsanto are supportive of growth. Demographic factors including an increase in global population and an emerging global middle class that desires an improved diet will put pressure on the existing food supply. A limited ability to increase arable land strongly suggests that agricultural productivity will be a necessary part of the solution to feed the world.

Monsanto is well-positioned to capitalize on these secular trends with its industry leading patent estate and product suite. The company has a multi-year product pipeline roadmap with products targeting yield enhancements and insect, weed and disease control for corn, soybean, cotton and other crops. Of note is the current success of Intacta, its Roundup Ready 2 soybean trait that has exceeded targets and has the opportunity to triple from its current 35 million acre penetration.

  1. Consolidation

If Problems are More Structural than Cyclical, the Industry is “Dealing” with It

Some theorize that the issues Monsanto and the rest of the agricultural industry are facing amount to something more than an ordinary cycle. There is a school of thought that the agricultural economy has become a victim of its own success, that the science behind the technology that has enabled farming to become more efficient has improved production in a way that has outpaced demand growth. The good news is that the agricultural chemical industry is behaving as if this is something more than a normal cycle. The prospect for consolidating agricultural seeds and chemicals was a key rationale for the pending deal between Dow and DuPont, not to mention BASF’s interest in DuPont. There was also the failed attempt by Monsanto (and successful announcement by ChemChina) to acquire Syngenta.

Monsanto has so far been on the outside looking in with respect to these actions. Perhaps the most significant risk for the bull thesis is the possibility of the company over-paying for an acquisition for fear of getting left behind in the wave of consolidation. The company has expressed a willingness to engage in partnerships/JVs, and such structures would likely limit this risk.

On the whole, consolidation should be a broad positive for the industry and Monsanto, resulting in a general improvement of competitive conditions, with more disciplined actors and likely improved pricing.

  1. Valuation

Near-term Headwinds Lead to More Estimate Cuts

Pressures in Monsanto’s business have increased in 2016 and the company recently cut its earnings guidance for 2016 to a range of $4.40 – $5.10, representing an EPS decrease of 17% versus 2015. There are a number of issues the company is contending with including:

  • Negative foreign exchange effects from Argentina, Venezuela, Brazil, Canada and Mexico
  • Glyphosate pricing declines
  • Compressed grower margins with low commodity prices
  • Heightened competition
  • A regulatory delay for the herbicide Dicamba in over-the-top applications

The long term prospects remain bright – EPS growth over the next four years compares favorably to the bulk of the chemical sector – Exhibit 2.

Exhibit 4

Source: Capital IQ and SSR Analysis

Risk/Reward is Attractive, Debt Not a Major Concern

Monsanto recently guided 2016 EPS to the range of $4.40-$5.10. A 16.5x multiple to the lower bound of that range implies a share price around $70 – downside of around 20% from current levels.

Consensus sees MON earning $7.80 per share in 2019. Our $130 price target is based on a more conservative estimate valued at a high teens multiple as summarized in Exhibit 1. This brings the stock roughly back to the highs achieved in 2014-2015.

Acknowledging that our return on capital/normal earnings based models are perhaps less germane to capturing the ag cycle, we see a similar “normal” price implied by MON’s return on capital trend, in the mid $130s range – Exhibits 5 and 6.

Exhibit 5

Source: Capital IQ and SSR Analysis

Exhibit 6

Source: Capital IQ and SSR Analysis

While MON has $1.2 billion in debt coming due over the next two years, the absolute level is not overly concerning relative to EBITDA – Exhibit 7 – or the company’s enterprise value – Exhibit 8.

Exhibit 7

Source: Capital IQ and SSR Analysis

Exhibit 8

Source: Capital IQ and SSR Analysis

©2016, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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