Since the end of the Federal Reserve’s $600 billion second-round of quantitative easing policy ended in the 1st half of 2011, commodity prices and commodity-based companies have been mired in a bear market, despite subsequent injections of stimuli by the world’s major central banks. Since peaking in April 2011, the CRB BLS Spot Index (a broad-based price index of 22 commodities, excluding energy) has declined by 35%, due to a combination of a rising U.S. dollar, overproduction, and a global economic slowdown, particularly in China.
Despite the current global economic headwinds, there are still pockets of growth within the commodity space that are underpinned by chronic supply shortages and ongoing, rising demand. For example—while China’s demand for copper and iron ore has stopped growing as its industrialization phase matured—the same cannot be said for the country’s consumer or aspirational spending as both the Chinese and Asian middle class continues to grow. One area that is underpinned by this growth in Chinese/Asian consumer spending is the structural growth in protein consumption, which is accompanied by rising demand for crops such as corn and soybeans. Investors in this space should seek out differentiated companies that provide vital products with high pricing power to farmers. Here, I find Monsanto (MON) to be especially compelling.
MON has a market value of $39 billion, and an annual dividend yield of 2.3%. I find MON to be a compelling rebound play for three reasons.
1. The long-term outlook for global protein and agricultural product consumption is highly attractive
MON is an innovator and a dominant player in the global agricultural biotechnology industry. The use of MON’s products—genetically modified seeds and agricultural productivity products such as Roundup and Harness—is vital to meeting growing protein and food demand in the long-run, given: a) the ongoing destruction of arable farmland around the world as nations urbanize and industrialize, b) the increasing volatility in weather patterns, including the increasing frequency of droughts, and c) increasing bug & weed resistance to older-generation genetically-modified seeds. This means farms around the world will need to be more efficient just to maintain current crop yields.
More importantly, demand growth for proteins remains fundamentally strong. China, for example, is shifting its growth policy away from an infrastructure and manufacturing-centric to one focusing on increasing consumer, aspirational spending. Over the next several years, I expect Chinese consumer disposable income to grow by at least 7%, which is over twice as high as that in the U.S. Even Chinese manufacturing wages—portrayed by the western media as suffering a major downturn—was up more than 5% last year. This means Chinese consumer spending, including protein consumption, will remain strong—thus buoying global agricultural products demand for the foreseeable future.
2. MON is the dominant leader in the agricultural biotechnology industry
MON operates two divisions: seeds & genomics and agricultural productivity. Within its seeds & genomics division, MON provides genetically & naturally modified seed brands to farmers that are designed to be insect- and herbicide-resistant. MON also licenses its seed traits to competitors, mostly because the latter find it difficult to compete with MON on seed trait innovation. Because of the superiority of MON’s seed traits and the firm’s licensing strategy, about 80-90% of all the soybean and corn crops grown in the U.S. have at least some trace of MON’s seed traits. Moreover, the firm consistently invests 10% of its sales into R&D (now at $1.5 billion); its core pipeline of innovation is expected to deliver up to $25 billion in peak annual net sales, up from $15 billion in the 2015 fiscal year.
Within its agricultural & productivity division, the firm manufactures herbicides such as its Roundup and Harness brands. While this division contributes only 32% of the firm’s revenues ($4.8 billion out of $15 billion in fiscal 2015 revenues), it is an integral part as it is complementary to the firm’s herbicide-resistant line of genetically-modified seeds. E.g. Farmers purchasing MON’s second-generation Roundup Ready 2 Yield trait for soybeans will naturally utilize the firm’s Roundup line of herbicides for weed control, and vice-versa.
3. MON’s management has a clear growth plan and its stock is attractively valued
MON’s fiscal 2016 EPS is projected to be between $5.10 and $5.60, which is below its $5.73 fiscal EPS, due to a) major currency headwinds stemming from its Brazilian and Argentine client exposure, b) restructuring charges as a result of its Brazilian sugar cane unit shut-down (which is not core to MON’s business anyway), and c) a decline in its agricultural productivity division’s gross profit. None of these headwinds are expected to last beyond fiscal 2016. In fact, MON recently indicated that dealer and grower order book volume and prepayments in the U.S. are tracking “modestly ahead” of the prior year despite continued pressure on commodity prices.
By fiscal 2019, MON expects its EPS to double from current levels, driven by its strong pipeline, stock purchases, and protein consumption growth in emerging markets. MON trades at a P/E ratio of around 17 based on its estimated 2016 fiscal EPS; this is about 32% below its 2010-2015 P/E average of 25. As growth returns to the industry, I expect MON to experience significant P/E expansion, which will bring the stock back to above $125 a share, or an appreciation of 41% from its current stock price.
Disclosure: Neither I nor does my firm, CB Capital Partners hold any shares in MON.
Henry To, CFA, CAIA, FRM is Partner & Chief Investment Officer at CB Capital Partners. Established in 2001, CB Capital Partners is a global financial advisory and investment firm headquartered in Newport Beach, California, with an office in Shanghai, China and an affiliate office in Mumbai, India. Visit http://www.cbcapital.com and http://www.cbcapitalresearch.com for more information.