Friday, 9 October 2015

Structural positives, tactical challenges...so what to think about Monsanto shares?

It has not been the greatest summer for Monsanto between the failed Syngenta bid (link here) and generally tough agricultural markets.  The last time I wrote up Monsanto results (back in June - link here) I observed that:

'...my instinct on Monsanto shares today is still to look at the US$100-105 area for a first potential opportunity buy level, adding each US$5-10 down'

And where are the shares of Monsanto now?  Basically US$90...


So the shares are a 'buy' now then?  Well...those aforementioned 'tough agricultural markets' (more later on this) are having an impact and full year 2016 forecasted earnings - as shown below - is expected to be sequentially down...although they still see 20% compound annualised earnings growth for the rest of the decade beyond here... 


...driven by product innovation (check out some of the potential RoIs below)...


 ...and inherent demand to help fill the need for greater crop yields:


I would agree with a lot of these strategic thoughts as a combination of need and innovation drives pricing and hence attractiveness in the underlying story for Monsanto.  Of course - following the failure of the merger talks with Syngenta - this forward story is more exclusively centred on seeds (a combination with Syngenta would have added crop protection interests).  

Back on these tough agricultural markets. There is little doubt that Monsanto's forward view on FY16F earnings were inherently disappointing and reflecting the tough conditions, Monsanto said it planned to cut 2,600 employees over the next two years which is equivalent to around 12% of its global workforce.  That's big / shows the magnitude of the slowdown in regions like Latin America.

Free cash is currently running around the US$2bn level but note that the target ND:ebitda is higher than the prevailing metric i.e. continue to expect over-distribution of the free cash flow generation.  This is reflected by the new US$3bn share repurchase plan (albeit with an additional US$1bn restructuring cost bill too to make the aforementioned job cuts and related).  


So let's put some numbers on this basically good structural story (with some tactical challenges).  At a US$42bn market cap and a US$49bn EV that puts the stock on an EV/ebit of around x12 and a free cash flow yield of 4.8% (with the observation that the proportional distribution is likely to be higher than this).  Underlying these are pretty attractive metrics.  Certainly we could continue to have a tough agricultural cycle and also - I guess - we could see the company come back to the Syngenta merger idea in a more hostile/aggressive way.  

So perhaps not the greatest surprise that the stock has underperformed even Syngenta over the last six months.  Nevertheless - and despite my recently sharply (re)augmented position in the Swiss company, my instinct is to initiate a position in Monsanto too here.  


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