Street Capitalist: Event Driven Value Investments

A while back I mentioned that Monsanto might be a company worth looking at because of their competitive advantage in the seed business. Unfortunately, the stock has moved a lot since we first posted about it at the end of June:

Up 21% in a little less than a month! Too bad I didn’t buy it back then.

Monsanto (NYSE:MON) has been a real innovator in their field, here is how they define their business:

Monsanto Company (Monsanto) along with its subsidiaries, is a worldwide provider of agricultural products for farmers. The Company’s seeds, biotechnology trait products, and herbicides provide farmers with solutions to produce foods for consumers and feed for animals. The Company operates in two segments: Seeds and Genomics, and Agricultural Productivity.

The thesis you often hear from agriculture bulls of the company is that if the developing world truly does continue its pace of development, we’re going to need more food to nourish those people and that food is going to be grown with the help of Monsanto’s products. Then, if there is a bull market in agricultural commodities — Mosanto’s products will be needed in order to help give farmers the ability to increase their yield and sell for higher prices.

So then what has been the bear case?

We just got out of an agricultural commodity boom and one of the things Monsanto did was steadily increase pricing on their products as the prices of commodities continued to rise. This made a lot of sense when prices for commodities were high, they were able to capture the benefits from the increased yield in their crops. But Monsanto did not adjust pricing as commodities started to fall. That caused a drop in sales which led to an increase in inventories.

Now, I haven’t had a chance to do much valuation work on Monsanto. I know the company on a more qualitative basis. But, Glenn Busch from ValueInvestingCenter has taken a stab at valuing the company:

The Seed and Genomics division is by far the largest division at Monsanto CO. (MON) based on revenues; it accounts for 62% of Monsanto’s revenue. In fiscal year 2009 the Seed and Genomics division had $7.29 billion in sales. For fiscal year 2009 the Seed and Genomics division had a Gross Margin of 61% and an Operating Margin of 22%. In 2008 Seeds and Genomics had an operating margin of 18%. The increase in margins has been due to the launch of newer- higher margin products. Margins are expected to continue to increase further based on more launches of higher margin products like Genuity VT Triple Pro Corn.

For the discounted cash flow that I will run on this division I will use an operating margin of 20% even though recent margins have been higher and are expected to increase further. I will use current interest expenses and taxes but I will use normalized Statement of Cash Flows line items. For growth rates, I will use the median analyst estimate of 10% and the lowest analyst estimate of 6%. I will use 10% as the discount rate because Monsanto CO. (MON) is a large multi-national company with minimal debt and a leader in its field. Currently, Monsanto Co. (MON) has 545 million shares outstanding and to keep it simple I will not factor in any share buybacks.

Below is the range of values for the Seed and Genomics division.

6% Growth = $51.00
10% Growth = $59.00

With Monsanto Co. (MON) currently trading around $57.00 we’re pretty much getting fair value for the Seed and Genomics division and everything else free.

Valuing Monsanto Co. (MON) (Value Investing Center)

According to Busch, one of the problems was in Monsanto’s agricultural products division. Monsanto produces a herbicide called Roundup, which featured lower adoption rates due to a flood of competitors (they lost patents) and some customers over pricing. They’ve had to reduce prices to clear out excess inventory which has carried over into their margins. Here is Glenn’s take on the division:

I will value the worst case scenario like a perpetuity using a discount rate of 10%. I’ve chosen to value the worst-case scenario like a perpetuity because Roundup is still the largest selling glyphosate product on the market. Glyphosate is also the largest herbicide in use and has been this way for a long time. Monsanto lost its U.S. Patent in 2000 and still has maintained a high level of Roundup sales. I would expect Monsanto to continue to sell more Roundup than what I’m basing this valuation on.

Below is my value for the worst case scenario.

$3.90

Valuing Monsanto Co. (MON) (Value Investing Center)

So in Glenn’s low case, Monsanto is worth $54.90 all together versus a current price of $57.32. Not a bargain, but it could be if we see another AgBoom because Monsanto could simply increase the prices on their products and reap the benefit. Glenn talks about this towards the end of his write up, which you should read to get the whole picture. I’ve only excerpted part of it.