The Global Demographic Tailwind

[DewDiligence]

Monsanto's Cropped Guidance

[This is a research report by Sterne Agee published in Barron’s. It goes into more detail than yesterday’s write-ups in the mainstream business press. (Glyphosate is the chemical in MON’s Roundup brand of weed killer, which is now off-patent and subject to generic competition. All quarterly and yearly numbers below refer to MON’s fiscal year, which ends on Aug 31.)]

http://online.barrons.com/article/SB125253244548297247.html

›September 10, 2009

Monsanto's (TICKER: MON) 2010 earnings-per-share guidance of $3.10-$3.30 is more of a comment on seeds and traits than on [herbicide] glyphosate – the glyphosate guidance is only marginally below our estimate, while seed and overall guidance is significantly lower. That implies that other agricultural chemicals may be weaker too, and that selling, general and administrative (SG&A) costs and research and development are higher.

While the 2012 targets haven't changed, the growth trajectory in seed appears to be more back-end weighted than we had expected, despite the good flow of new-seed products coming out of the pipeline. We have reduced our fiscal 2010 EPS estimate to $3.25 [from $4.20].

Very high expected U.S. corn yields have been raising the risk that U.S. corn acres in the 2010/2011 farm season would be lower. With the corn crop so late, there is still considerable uncertainty about yields, and an early frost could easily push corn prices higher. But with expectations of fair weather, corn prices are keeping farmer profitability down.

Monsanto is pricing its SmartStax corn seed aggressively, which suggests a high degree of confidence in efficacy. But SmartStax is a small part of the seed mix in 2010, and if overall corn acres are down, we could see both lower volumes and lower prices for the rest of the corn-seed lineup. We suspect that is part of the reason that overall seed and trait gross-profit guidance is below our expectations.

Outside the U.S., farm profitability has also been weaker, and that is already reducing demand for ag inputs in Brazil, Argentina, and elsewhere. Weather has affected demand this season in places like India, but that should help Monsanto in 2010, if weather returns closer to normal.

We were already using $750 million for glyphosate gross profit [the same on MON’s new FY2010 guidance], and we were using lower volumes than the 250 million gallons Monsanto is now suggesting. So glyphosate is not a big part of the gap between our numbers and guidance. Moreover, with weak ag-input markets, producers' ability to clear the inventories has probably been pushed back further into 2010.

Once the excess inventory is cleared, we do see room for branded-product margins to recover somewhat, and we think the earlier guidance of $1.0bn in 2012 should be achievable. What Monsanto is seeing in their other (nonglyphosate) ag chemicals isn't clear, but we suspect that they are moving down with the rest of ag inputs.

While investors have been skittish about attaching too high a multiple to the seed business at a time when overall company-earnings growth has turned negative, we view seed as a highly sustainable growth business. Indeed, despite the setbacks for ag inputs, there has been virtually no change in the trajectory of agricultural investment and policy-reform globally -- lower grain prices have not discouraged governments from their efforts to increase ag profitability and to create incentives for farmers to invest in their businesses, even if credit has slowed the dollar inflows. As we see it, the politics of food-price inflation remain front-and-center for most government policy makers, and that makes Monsanto's pipeline of new products tremendously valuable.

True, with corn prices lower, the value of that pipeline is potentially lower, but with no decline in the push for ag productivity, we expect high-value seed to capture an increasing share of farmers' budgets over the next several years, relative to other ag inputs.

We are taking our price target down to $100 (from $110) to reflect the slower near-term profit outlook, but we expect this new guidance to provide a "floor" for earnings for investors to work with. Investors have been looking for some clarity on 2010, and the weak ag-input market and late corn season has made it difficult to find that clarity. While disappointing, this new guidance should help investors recalibrate.

We rate Monsanto at Buy.‹