Monsanto Performance Proves there is Life in Ag Market

The markets are collapsing. The country of Iceland is on the verge of Chapter 11. Detroit is about to close down completely. Credit markets have seized and investors are rightly running away from companies that rely on credit to sustain their businesses. 

Most people probably missed them, but there are a few bright spots. After a huge fall in commodities that was similar to the dot-com bubble condensed into a three-month period, there are now some real values.

One of those sectors is in agriculture. We watched the entire sector climb to frothy highs, watched its seemingly unstoppable fall, and now it’s anyone’s guess what ag stocks are going to do over the next day, week, and month.

Although, once a short-term rally begins, fertilizer stocks will likely be there in a big, big way. The sell-off has been unwarranted as hedge fund redemptions have gone through the roof. But the long-term outlook for agriculture has remained strong despite the recent downturn in agriculture stocks.

With everything going on, the agriculture industry is starting to show how strong it has remained. Yes, the bubble in fertilizer prices has popped. Agriculture commodity prices have come back to reality. But they’re still higher than the long-run average and, when the markets return to normalcy, agriculture will be one of the leaders once again.

After all, oil demand will likely cool off until the global economy gets turned around. Demand for copper, zinc, silver, and other base and industrial metals will likely continue to stagnate as well. But the argument that people have to eat still holds true.

One of the leading benefactors of it all has been Monsanto (NYSE:MON). As a maker of seeds that grow into plants that grow bigger, are customizable to different qualities and types of soil, and are more resistant to pests, Monsanto has gone along for the ride in agriculture stocks.

And while the markets plummeted and speculation over the government’s next move, Monsanto showed the agriculture markets are as strong as ever. Monsanto released its latest earnings report last week. Despite the lack of positive reaction from the market, the company proved the fundamental agriculture market is as healthy as ever.

Monsanto reported some pretty good top and bottom line numbers. The company reported a loss of 3 cents per share compared to consensus estimates of a loss of 4 cents per share. Revenues for seeds and traits increased 27%. Revenue for herbicides and crop protection products increased 43%.

Also on the positive side, the company added that it expects gross profit to rise to $9.5 billion by 2012. That’s 53% higher than its gross profit in 2008 and marks an annualized growth rate of 11.3%. Granted, not much to get excited about, but with recession looming, dependable and achievable growth should be welcomed.

But to find out how truly healthy a business is, we’ve got to look at the operating margins. Expanding operating margins show a company is basically squeezing more profits from every dollar in revenue. Shrinking operating margins show a company is not able to earn as much per sale even though revenues may be expanding.

 In this case, Monsanto’s operating business is as healthy as ever and getting healthier.

Over the past four years, Monsanto has been able to expand its operating margin from 11.8% to 17.6%.

Of course, we have to worry now about the impact of a recession and continued tight credit markets. After all, most farms operate almost entirely on credit. Farms borrow big to start the year for seeds, fertilizer, and everything else. Then pay it all off at harvest time.

That’s what could create an additional opportunity for a cash flow machine like Monsanto. Even though credit for farmers hasn’t yet and probably won’t, Monsanto could easily fill in the gap. It has current assets of $7.6 billion and current liabilities of $4.4 billion. It already extends a good amount of credit to its customers with current accounts receivable of just over $2 billion, but it has the financial strength to extend even more.

When it comes to safety in agriculture stocks, Monsanto is one of the safest bet. Monsanto’s seeds will always be in demand. Demand for fertilizer will fluctuate somewhat with the prices of their crops farmers expect to get. The purchase of new tractors, harvesters, and other equipment can be put off. But seeds are an absolute must each year.

That level of safety shows in Monsanto’s recent share price performance. Its shares are only down 47% (wow, who ever though “only” would precede “down 47%”) from their highs this year.

But if you’re going to invest in agriculture now, you’ve got to remember a few things. This is not 2006. We are not in for 10% to 15% returns each month in ag stocks. That time has passed. The agriculture story has played out and now it will have to be driven by fundamental demand growth.

Most of the fall in agriculture commodity prices has been built in. And we’ll likely have an even clearer picture of how well the fundamentals are holding up over the next few weeks. Bunge (NYSE:BG), one of the most diversified agriculture companies, reports earnings October 23rd. Then in November Deere (NYSE:DE) and Agrium (NYSE:AGU) report earnings.

Also, agriculture stocks are still relatively high compared to their previous lows set a few years ago when no one cared about agriculture. Since the start of 2004, Potash Corp, Agrium, Mosaic, and Monsanto are up 540%, 160%, 170%, and 440% respectively.

So, it will take a long time for these stocks to return to their euphoric highs set earlier this year. It’s probably best to use a more conservative investing strategy. One that will allow you to start buying today, have you positioned to enjoy the inevitable and likely sharp rallies, and still benefit from any further sell-offs. Although with markets as volatile as they are, there could be more downside to come.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing