Monsanto (MON 90) has lived up to its promise to deliver the technological innovation
that is driving productivity in global agriculture. Monsanto started mapping the plant genome in
the late 1970’s, paving the way for its basic innovation of using genetics to
streamline plant hybridization.
Hybridization is the alteration of the plant genome. It has been performed by humans for 200 years
to improve food crops, traditionally implemented through plant breeding or seed
irradiation. Monsanto uses gene
insertion to incorporate desirable traits into the plant genome. The insertion of more than one trait is
called “trait stacking.” Initially
delivering traits such as insect resistance to reduce pesticide usage and
increase farmer’s productivity, the company has added many additional traits
and has a jam-packed pipeline of new ones to commercialize over the next ten
years. A recently introduced trait that
makes corn produce 10% more ethanol has particular economic appeal to farmers. Of interest to consumers is the Vistive soybean
trait that enables the “zero trans fat” foods now promoted
by fast food chains and food processors.
Two traits in the pipeline, drought resistance and nitrogen utilization
efficiency, have blockbuster potential. Through
stacking, a multitude of traits can be built into one seed, driving high yields
for farmers and profits for Monsanto.
All traits Monsanto supplies
improve crop economics for farmers. Monsanto
is compensated by being paid a royalty for each trait inserted into the
seed. The royalty is approximately
equivalent to one-third of the farmer’s incremental profit improvement attributed
to the trait. Since the seed production
cost is about the same, no matter how many traits it has, more traits per seed
multiply profitability for both farmers and Monsanto. However, Monsanto typically has invested ten
years of development expense in each trait, and annually spends about 10% of
revenues on future products. A few years
ago, we looked forward to the day when Monsanto could stack three traits into
one seed. That day is here. Now Monsanto projects stacking eight traits
in 2010.
I recently attended the Farm
Progress Show in
The above pictures from the Farm Progress Show are
side-by-side comparisons of soybeans growing with and without Monsanto traits.
Two traits of unprecedented
opportunity are drought resistance and nitrogen efficiency. Rainfall is clearly an issue in growing
crops, a risk that varies with geography.
Agriculture consumes 30% of the water used on this planet. For some farmers watering is just a
significant expense, while for others it is survival. Corn requires over 20 inches of combined
irrigation and rainfall. Watering costs
about $16 per acre. If a farmer can
reduce water application by 6 inches per year due to improved plant water
efficiency, he saves $96 per acre. In
geographies that lack irrigation, drought resistance improves yield. It may even save the crop in a drought
year. This trait should be priced at
several times that of traits like insect resistance, will be available in 2012,
and is highly desirable worldwide. Also,
it should expand arable acreage, including barren (and hungry) areas of the
world.
Nitrogen is a component of
fertilizer that depends on the price of natural gas and currently costs corn
farmers about $65 per acre. Monsanto’s Nitrogen-Utilization
corn trait should be available in several years. It reduces the amount of nitrogen fertilizer
a plant needs by 80%, mitigating the impact of high energy costs for the
farmer. It could earn Monsanto several
times the amount of fee earned on existing traits like corn borer resistance.
Monsanto has six objectives
to continue the excellent growth of its business:
1)
2) International corn –
increase market share in Europe,
3) Global biotech traits –
drive Roundup RReady soybeans in
4) Cotton – The recent
acquisition of the Delta and
5) Seminis – The acquisition of
Seminis has provided a platform for bringing traits to vegetables.
6) R&D pipeline – Increase
the number of new traits approved for usage worldwide.
Monsanto has evolved into an
incredible long-term growth engine as it leads innovation in a huge worldwide
business. Expansion of seed market share,
multiplied by stacking more traits on each seed, multiplied by increased
penetration into vast foreign markets, multiplied yet again by increasing
planted acreage give Monsanto virtually unparalleled revenue and earnings
growth visibility. Following three years
of 25% compounded annual earnings growth, we believe that analyst estimates for
the fiscal years 2008 to 2012 of $2.45, 2.94, $3.53, $4.23, and $5.00,
respectively, understate the opportunity.
Widespread investor awareness of the company’s story, combined with
investor enthusiasm for biofuels, has driven the price to very lofty
levels. The price is now somewhat above
our estimate of the company’s intrinsic value.
Compare this to the pitiful valuation Monsanto had when we capitalized
on widespread ignorance about the company to accumulate most of our
position. We caution that unpredictable
risks such as weather and regulatory issues worldwide have significantly
impacted the stock price in the past, and may in the future. Even the price of gasoline is a risk for
Monsanto, because of the significant role ethanol has played in the price
appreciation. Our considerable long-term
optimism is tempered by concern for the stock price.
Steven L.
Ré, CFA October 15, 2007
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