It’s All About Corn: Monsanto Up 46% in a Year

It’s confusion time around the corn crop. Planting started slowly this spring due to soggy soil, then finished up in some locales in record time. Farmers are anxious after last year’s drought, which depressed yields and boosted corn prices.

Uncertainty? Good news for Monsanto (MON), both in the short-term and the longer-term. The more farmers worry about uncertain outcomes, the more they will seek to maximize their crop size. That means a heightened demand for seeds – the U.S. government forecast that farmers would plant the biggest crop in some 75 years this season -- and makes it more likely those farmers will turn to Monsanto’s seeds, pricier but genetically modified to resist drought and deliver maximum yields. The de facto monopoly status of some of those seed products was confirmed by the recent unanimous Supreme Court ruling in favor of Monsanto, upholding its patent rights in a case involving a Midwest farmer. The company’s stock price has reflected its very strong financial performance as well as this patent ruling and the market backdrop.

MON Chart

MON data by YCharts

The question now is whether Monsanto’s stock has become like its seed products – pricey, but perhaps worth it – or whether the rally has propelled it to a point where even the most determined bulls should refrain from chasing it higher. Certainly, trading at about 22 times earnings, Monsanto is priced at a premium. But its PE ratio has grown less rapidly than has its price over the course of the last year. For instance, while Monsanto’s earnings jumped 22% in the second quarter of 2013, its share price is ahead only 10.8%. Actual and potential rivals like DuPont (DD), Dow Chemical (DOW) and Syngenta (SYT) command valuations that are roughly equivalent to significantly higher than that of Monsanto, which was ahead of the curve in shifting the focus of its business away from chemicals and into agricultural products like seeds, fertilizers and pesticides.

MON Revenue Annual YoY Growth Chart

MON Revenue Annual YoY Growth data by YCharts

Indeed, by most financial metrics, Monsanto is doing very nicely indeed, thank you: the company again boosted its outlook for its fiscal 2013 earnings to between $4.40 and $4.50 a share, up ten cents from its previous outlook. More intangibly, the stock serves as a play on growth in the emerging markets: as millions of people move up the economic ladder and are able to spend more of their disposable income to add protein to their meals, that drives demand for reliable sources of grain. (The calculation runs something like this: to create a pound of protein in the shape of beef, chicken or pork, requires anywhere from two to seven pounds of grain as an ‘input’ in the form of animal feed.)

Now that the Supreme Court patent case is behind it, however, Monsanto does continue to face one risk – and it isn’t its valuation. It is something that doesn’t command instant attention from a scrutiny of its top-line financials, but is only identified by those looking at the company’s business mix. The risk is the company’s heavy dependence on corn seed. That may not seem like much of a problem, given the fact that corn is such an ubiquitous product, making its way into everything from processed foods to ethanol, but it does mean that any problem with its corn products – a loss of effectiveness, new patent problems, any quality concerns – could wreak havoc on its financial wellbeing. Nor is there any evidence that the company is succeeding in diversifying its sales: sales of soybean seeds and traits fell 1.7% in the second quarter; cotton seed sales tumbled 9.1%; vegetable seed sales dropped 7.4%. Thanks to corn, however, the overall seed sales data looks robust, having climbed 11% for the quarter.

MON Gross Profit Margin Quarterly Chart

MON Gross Profit Margin Quarterly data by YCharts

To be an aggressive buy – a stock to chase even as it climbs back towards its 52-week high and beyond – Monsanto needs to show some evidence that it can diversify beyond corn, which currently makes up about 75% of its seed sales. That could come from sales of other seed products, or by boosting its productivity business, which focuses on the sale of herbicides and other crop protection products. Right now, this group generates only about a fifth of Monsanto’s total sales, but in the second quarter saw a 37% jump in sales, thanks to what the company described as a less cut-throat market as generic alternatives seemed to pull back from aggressive price cutting or otherwise lost market share. It also might help for Monsanto to see a year-over-year increase in its gross margins, rather than the small decline reported in the second quarter.

At its current prices, and in the wake of its gains this year, Monsanto remains a stock to like, if not quite to fall in love with. Yes, it pays a dividend – but a dividend yield of 1.43% isn’t overwhelmingly appealing, especially when much of the growth that the company is anticipating may already have been priced into the stock for now. Instead, keep a close eye on how this year’s corn crop is taking shape, and look for an opportunity to jump into Monsanto when the perfect combination materializes: bad crop news and/or higher corn futures prices (signaling both the need for larger crops and the possibility that farmers will be more able to pay a premium for Monsanto’s seeds) and a somewhat lower price for Monanto’s shares. In the absence of any evidence that the company is not only increasing its corn seed sales but those of other products, that’s what you should seek out in order to be a die-hard bull.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.

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