Monsanto: Ready to Blossom?


By Amy Tsao For years, Monsanto's (MON) blockbuster herbicide Roundup was the unassailable market leader. But that started to change in the fall of 2000, when the U.S. patent expired. Since then, sales have been falling steadily, despite the St. Louis-based chemicals-and-seeds outfit's best efforts to price Roundup more competitively with copycat herbicides and convince farmers to buy variations of the original product. In fiscal year ended August, 2003, Roundup sales fell to $1.8 billion, down from $2.5 billion in fiscal 2001.

Investors, however, probably shouldn't panic. The decline is moderating, analysts say, while Monsanto's other business -- genetically modified seeds -- generated $1.9 billion in sales in fiscal 2003, fully 39% of $4.9 billion in total revenues and up 22% from fiscal 2002. As this shift progresses, profits should rise, too: The seeds business has an operating margin of 16%, vs. about 11% for Roundup and Monsanto's other chemical products.

REVENUE CREEPS, EARNINGS LEAP. Other factors are working in Monsanto's favor, too. Recent positive trade developments in Brazil and the European Union should help. Plus, management has been setting Wall Street's expectations on the low side. Monsanto CEO Hugh Grant, appointed last June after three years as chief operating officer, "has adopted more of an underpromise and overdeliver mentality," says Fulcrum Global Partners analyst Frank Mitsch. (Mitsch does not own shares of nor does his firm perform banking for Monsanto.)

Wall Street also is optimistic that Monsanto can complete its shift to focusing mainly on agricultural seeds. Its shares, which trade at $30 and change, hit a 52-week high in recent days amid growing optimism that it can meet or exceed its goal of 10% compounded annual earnings growth in 2005 and 2006.

Monsanto's revenue growth will be weak during the next two years, increasing just 2.1% in 2004 and perhaps even falling 1% in 2005, estimates Morgan Stanley analyst Les Ravitz. However, he figures 2004 operating income will surge 24%, to $584 million, with the help of new products and cost-cutting, After that, earnings gains will slow to annual increases of a still enviable 10% to 12%. (Ravitz doesn't own the stock. Morgan Stanley does perform investment banking for Monsanto.)

BRAZILIAN ROYALTY. Meeting these expectations will require that Monsanto's new seed products achieve strong sales growth. So far, demand is strongest for its "stacked" seeds, which incorporate multiple desirable traits in a single seed. "Stacking traits provides meaningful advantages to growers," says Banc of America Securities analyst Kevin McCarthy, adding that Monsanto's competitors now have no commercialized multiple-trait seeds on the market.

Monsanto spokesperson Lori Fisher says stacked-seed sales rose 132% from 2002 to 2003. While predicting that sales should remain strong in coming years, she declined to provide specific projections.

International markets are showing some hopeful signs, too. On Jan. 28, Brazil's farmers, who largely have been pirating Monsanto's seeds, agreed to pay royalties for the use of its genetically modified soybeans. The exact amount and other details have yet to be determined, but analysts see the decision as positive for Monsanto, whose seeds account for as much as 90% of that nation's soy crop. Mitsch figures that the Brazil royalty deal, if finalized this year, could add 5 cents to 10 cents to Monsanto's fiscal 2004 earnings. On average, analysts expect earnings per share of $1.55.

MORE LIKE A BIOTECH? Good news is emerging as well from the EU, a major opponent of genetically modified crops. In January, EU ministers said they would consider allowing imports of a gene-altered corn, made by Swiss seed outfit Syngenta. A vote in favor of the corn -- in food form only, not for planting -- could pave the way for Monsanto's customers to sell their produce in Europe, too. The EU will consider making a similar allowance for Monsanto corn beginning as soon as this month.

Monsanto also has many more gene-based products under development. Among the most promising are seeds that enhance water and nitrogen utilization and improve a plant's ability to withstand cold weather. These should reach the market by 2008. Also in development: Seeds that would yield crops richer in vitamins. "In broader terms, Monsanto is only starting to scratch the surface," say Banc of America Securities' McCarthy. (McCarthy doesn't own shares. BofA has an investment-banking relationship with Monsanto.)

Over the longer term, with seeds making up more of the business, McCarthy figures Monsanto will "more closely resemble a biotech company" in terms of profit margins. That could mean a major increase in profitability -- Amgen (AMGN) and Genentech (DNA) enjoy profit margins of 18% and 27%, respectively. McCarthy figures Monsanto's seed business should already be valued more like one of those biotechs, whose stocks garner forward price-earnings ratios of 30 or more, vs. Monsanto's p-e of 19.

GM RESISTANCE. With such prospects come heightened risks. Genetically modified seeds have been embraced in the U.S. with only minor opposition. But resistance remains strong in Europe -- so a key market is, at best, years away and may never develop. Furthermore, Monsanto has large potential legal liabilities related to debt owed by Solutia, a bankrupt chemicals outfit that was formerly part of Monsanto. Also a Justice Dept. price-fixing investigation that centers on Roundup was disclosed last March.

These are big risks, but Monsanto's solid cash flow and clean balance sheet provide investors with no small degree of comfort, Ravitz says. And if its genetically altered seed business can gain even a little more traction overseas, doubts about Monsanto could soon begin to wilt. Tsao covers the markets for BusinessWeek Online and writes for the Street Wise column


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