stock analyisis report - monsanto (mon)

8/2/2019 Stock Analyisis Report - Monsanto (MON)

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University of Puerto Rico at Mayagez

23/11/2011

Prof. Ruiz

Gabriel Irizarry Prez

802-05-3704


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Introduction

The firm was founded in 1901 by John F. Queeny to sell saccharine and it wasnt until forty-four

years later (1945) that the company began producing and marketing agricultural chemicals. Since

then, the company grew and diversified its business divisions by including agricultural products,

pharmaceuticals and nutrition and chemical products businesses. It later spun each of them intoseparate companies. Thus, as of September 1, 1997, the company formerly known as Monsanto

Company became the company Pharmacia (at that point its name was Monsanto Ag Company)

while the industrial chemicals and fibers business operations, assets, and liabilities were

transferred to Solutia, Inc. Then in 2002 the agricultural business was spun off and became

Monsanto.1

Today the Monsanto Co. is divided into a Seeds and Traits segment and a Crop Protection

segment. The first is the principal line of business and probably the most controversial given its

unusual and innovative practices in the genetics field.

The company is part of the Agricultural Chemicals Industry and the Basic Materials Sector.

Moreover, its the second (to United Phosphorus Limited or UFL, headquartered in Mumbai, India)

largest company in its Industry in terms of market capitalization. However, Potash Corporation

and Chambal Fertilizers LTD have a similar value of market capitalization.

Its current headquarters are located in St. Louis Missouri. It has established operations globally in

all continents with the intent of better tailoring to the needs of its local customers. The 404

facilities in 66 countries (excluding the 146 in the USA) have been arrived at through a

combination of mergers, acquisitions, joint ventures and agreements. Indeed, this company has

substantial direct foreign investment.

In order for the company stock to be traded on the NYSE, it has to register as a public company

with the SEC. As part of the registration its Financial Reports are prepared by Deloitte & Touch

LLP.

1http://www.monsanto.com/whoweare/Pages/monsanto-relationships-pfizer-solutia.aspx
http://www.monsanto.com/whoweare/Pages/monsanto-relationships-pfizer-solutia.aspxhttp://www.monsanto.com/whoweare/Pages/monsanto-relationships-pfizer-solutia.aspxhttp://www.monsanto.com/whoweare/Pages/monsanto-relationships-pfizer-solutia.aspxhttp://www.monsanto.com/whoweare/Pages/monsanto-relationships-pfizer-solutia.aspx


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Macroeconomic Review

The Composite Leading Indicator (LEI) and the Composite Lagging Indicator (LAG) have been rising

for the past six months. On the other hand, while the Coincident Composite Index (CEI) had

remained unchanged in the months of August and September, it had a growth of 0.2% in October.

Looking at the numbers (graphed below), it seems that there is a forthcoming economic

expansion.

Moreover by looking at the percentage growth month to month, we see that none of the three

indexes has seen a decline (see graph below) for the past 6 months. This is further evidence of a

favorable economic environment.

112.48 112.59 113.49114.51 115.31 114.97 115.31

115.89 116.24 116.35117.40

102.16 102.47 102.68 102.57 102.78 102.88 102.98103.29 103.29 103.29 103.50

108.17 107.84 108.06 108.38 108.71109.25 109.69 109.91 110.13 110.24

110.90

90.00

95.00

100.00

105.00

110.00

115.00

120.00

MonthlyChange

Monthly Change in Composite Economic Indicators

LEI CEI LAG*Source: Conference Board

-0.40%

-0.20%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

M

onthlyChange

Monthly Change in Composite Economic Indicators

LEI CEI LAG*Source: Conference Board


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However its important to note that the ratio of CEI/LAG is decreasing at the same time that the

LEI is increasing (see chart below). This is typically a signal of a possible end to the economic

expansion or a less-robust one as pointed by Reilly & Brown in the class textbook (Investment

Analysis and Portfolio Management).

Even as the CEI didnt rise as much as what would be ideal (positive change greater than the

change in LEI), the industrial production and employment indicators were somewhat responsible

and this is a key aspect in averting a recession. (Most economic literature indicates, an economic

expansion is unsustainable when coupled with high unemployment.) According to the Pressrelease by the Conference Board, the lack of consumer confidence continues to be the major

cause of sluggishness in the market momentum. However, the latest surge in the LEI could drive

the market higher during the next three to five months.

On the other hand, the U.S. Economic Forecast provided by the Conference Board indicates that

the Real GDP percentage growth for 2011, 2012, and 2013 will be 1.7, 1.1, and 1.9 respectively.

These are anemic growth numbers, with consumer spending and real capital spending

foreseeing declines of 14.7% and 23.9% respectively.

In the global front, according to the Economic Situation and Future Perspective report, by BBVA

Research, the Global Index of Business Expectation had a weak growth in the second trimester of

the current year and fell in the third. Also, the implied volatility of the stock and debt markets is

beginning to affect the Emerging Economies in a contagion effect. The Financial Stress Index (of

both BBVA Research and St. Louis Fed Economic Data) shows that the current levels are unseen

from fall of 2008. Additionally, emerging economies have continued their dinamyc growth while

Europe has continued to face problems in Greece, Italy and Spain. Notwithstanding, as per-capita

income continues rising and population continues growing in emerging economies, the price of

0.90

0.95

1.00

1.05

1.10

1.15

1.20

Ratio

LEI & CEI/LAG

CEI/LAG LEI*Source: ConferenceBoard


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crops rises. Considering the global nature of the companies operations, this are positive news,

especially since emerging economies account for more than 50% of World Output. Even if the two

problem economies (Italy and Greece) were to have a slowdown, they dont account for much of

this Industrys demand.2

Lately, interest rates have been pressured by the decreasing inflation, increased money supply,consumer demand, and corporate profits. At the same time, there was a slight surge in GDP,

demand, and income. Notwithstanding, yields have climbed because of the financial stress faced

by banks. Earnings on the other hand grew slower due to the decreases in prices and increased

inventories.

The spread in bond yields is widening, which means that investors require a higher premium. This

could be because of higher inflation expectations or higher perceived risk. On the other hand, the

Inflation-Indexed Treasury Yield Spreads are rising, and this indicates that the Fed expects higher

inflation. Since there is a negative relationship between the inflation expectations and the rates

of return on bond and stock prices, this is a negative outlook for financial assets. This has

translated into slow market growth in most of the worlds stock markets.

Projected Macroeconomic analysis

A future upward shift in the SML Line will result because of the higher inflation expectations (weak

consumer and business sentiments not necessarily a bad sign because of the inconsistencies

between what people say and do); this will be offset in part by a lower real economic growth.

Moreover, the market risk premium (slope of SML Line) will be pressured down, causing a further

partial offset of inflation expectations (that is, required return (k) will have a small rise). Corporate

growth rate of dividends (g) will reach 2009 levels from 2012 through 2017 due to higher inflation

and a recovery in developed countries. As mentioned before however, the g will slow down in the

period 2017-2025. Thus, as emerging economies will start seeing a drop in g immediately, they

will remain growing faster than the developed countries economies. In this case (k) will go up by

less than the growth rate of dividends (g). In summary, the k-g spread will widen in the short term

(until 2012); it will narrow in the intermediate term (until 2017); and finally widen somewhat, but

less than in the short-term (until 2025); stock prices in general will be forced up in the long term.

2Their aggregate consumption is approximately 1.04% of Global Consumption of Pesticides and Agricultural

Chemicals.


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Relevant Stock Market Prospects

The Market has been having 100 point days on a regular basis, as of late. These swings have

come due to the slur of mixed economic data (positive & negative). On one hand we get the

positive corporate earnings, decreasing unemployment, and stronger-than-expected housing

starts and sales, but on the other hand theres the Debt crisis in Europe (especially in Greece &Europe), failure of the Super Committee in charge of US deficit reduction, and even a recent

error headline of a possible downgrade of the French Government debt.

Notwithstanding, there are positive headwinds. First, new Prime Ministers of Greece and

Italy, Lucas Papademos and Mario Monti seem to be well respected technocrats.3 The French

debt downgrade was merely an error, so theres not much worries there. The emerging

economies continue to grow strongly, even if they are expected to begin slowing after 2012.

Finally, while the Super Committee may not find a feasible deal for the needed $1.2 trillion

in deficit reduction, this isnt as alarming as the recent debt ceiling debate.

The month return for the U.S. equity markets in October was one of the best in several years,

while the YTD for the S&P 500 (which captures near 75% of U.S. equities (Standard & Poor's

Financial Services LLC, 2011)) return is near -3.5%. Contrary to the late summer predictions of

many who said that U.S. would sink into a double-dip, that Europe was falling apart, and that

China was slowing down, the GDP, corporate earnings and other economic indicators &

variables seem to point to an acceleration of growth. Moreover, equity markets in most parts

of the world have appreciated by double digits since the beginning of these troubles. The

question for many remains whether or not the European debt problems can be solved. (Doll,

2011) This is especially true because of the current global interactions (e.g., Chinas and other

Southeast Asian Nations economic growths depend largely on developed countries demandfor their manufactured products as well as other trades). (Wardlaw & Wong, 2011)

3According to Investopedia, a technocrat is a politician who may not possess the political savvy or charisma

to sway public opinion but demonstrates more pragmatic and data-oriented problem-solving skills in the

political arena. See:http://www.investopedia.com/terms/t/technocracy.asp#axzz1eUqApJgi
http://www.investopedia.com/terms/t/technocracy.asp#axzz1eUqApJgihttp://www.investopedia.com/terms/t/technocracy.asp#axzz1eUqApJgihttp://www.investopedia.com/terms/t/technocracy.asp#axzz1eUqApJgihttp://www.investopedia.com/terms/t/technocracy.asp#axzz1eUqApJgi


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Review of the Company and its Business

Industry analysis

Monsanto Co. is part of the Specialty Chemicals Industry. This decades old Industry has

numerous subsectors within it, but the agricultural chemicals subsector business of

genetically modified seeds and traits originated merely 15 years ago.

Demand for the agricultural chemicals remains strong because of the staple nature of

most food products. Moreover, the seasonal and weather conditions (e.g., the recent

hurricanes in Texas and floods in Australia) should insure high demand for this next year.

(Wardlaw & Wong, 2011)

Today, economic thought has integrated the importance of productivity in the

development of a country. Thus, products in the agricultural chemicals industry are

increasingly being seen as a staple and its demand patterns will behave as such.

Moreover, the humanitarian roles of Agrochemicals may prove them necessary as theyexpect to revolutionize African poverty through their productivity. (Clive, 2010)

Because the values of society today may become tomorrows regulations, this high waste

and emissions industry could face more and more stringent regulations tomorrow. For

example, further regulations that involve social ends such as the Consumer Protection Act

and EPAs Statutes and Policies. As of today, three federal agencies serve as regulators for

biotechnology and chemical products such as Monsantos herbicides and seeds. These are

the FDA, Department of Agriculture, and EPA. There at least ten different laws and

numerous agency regulations and guidelines that apply to them as well as some that were

created specifically because of such products. Some of the most notable are:

1. The Federal Insecticide, Fungicide and Rodenticide Act;2. The Plant Protection Act;3. The Public Health Service Act; and4. The National Environmental Protection Act.

Other countries have other regulations and some even outlaw it entirely. Still, this could

be expected to change gradually as more experiments and knowledge about the product

are obtained.

Industrys life cycle

This industry has been widely accepted in the U.S. Market, as can be seen in the Adoption

of Genetically Engineered Crops in the US(below), Americas and many Asian countries;

yet, many European countries still have severe restrictions against the use of such

technologies. (The Economist, 2011) In fact, the percentage of crops around the world

that had adopted genetically modified (GM) seeds in 2010 was about 47.62%. At the same

time, the number of countries that had adopted (and permitted) these technologies were


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29; this amount is expected to grow by twelve into the year 2015. (Clive, 2010)

Additionally, theres still space to innovate in this industry, especially with the green

trends that are spreading each day.

On the other hand, as can be seen in the Yearly Performance Graph (below), the

performance for this Industry (NAICS 325320) has been consistently above the S&P 500

since 2000 and has had less volatility. That is, it had a higher annual return than the S&P

500(13.69% vs 0.0%4) and clearly didnt have as much volatility. Moreover, it doesnt

seem to have a cyclical pattern (in terms of stock market cycles). Since risk within an

industry is fairly stable over time, we can conclude that the past industry risk is a goodfuture estimator. (Reilly & Brown, 2009) Its worth noting that the best performer, by far,

was the Global GDP. The annual return on Worlds GDP was 65.24%, having negative

returns during the 2001 terrorist attacks and 2008 financial crisis years only. This is great

news for this industry; if it could effectively profit on the expected growth in income per-

capita, population, and enter the expected number of countries it will be able to obtain

above market returns.

4Geometric average used for a decennial 81.97% for the World Exports of Pesticides and Agricultural

Chemicals; the same was done for the -4.74% decennial return for the S&P 500. The actual annual return for

the S&P 500 is approximately 0.000000000000578%.

0

10

20

30

40

50

60

70

80

90100

1998 2000 2002 2004 2006 2008 2010 2012%ofGeneticallyengineeredCrop

Year

Adoption of Genetically Engineered Crops in

the US

Cotton

Soybean

Corn

*Source: U.S. Department of Agriculture


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As discussed, even though theres a substantial opportunity for growth left in the industry, the

demand for the industry goods is clearly well established. Moreover, its expected to keep beating

the market and is less risky (its growth is still notable and virtually inevitable). This is enough

evidence to rule out the rapid accelerating growth (excess demand and profit growth above

100%). Likewise, while it has some characteristics of an industry in its Mature Growth phase (such

as expected innovation and above domestic market returns), a closer examination at the

industrys correlation with the Global economy demonstrates that its growth has become highly

explicable by demographic or macroeconomic variables such as growth in income per-capita and

population as well as some sociopolitical dependencies. In fact, the correlation coefficient for the

Global Industry Exports and the Global GDP is 0.94. As shown in the plot of Global Exports of

Pesticides & Agricultural Chemicals vs Global GDP5 (below), there is a significant linear relationship

between the two and the beta for the Exports is approximately 0.72, as indicated by the

Regression Function. Thus, the industry is clearly in the Stabilization and Market Maturity phase.

5GDP numbers have been coded to have a linear and more understandable Beta.

-1

0

0

0

0

00

0

0

1998 2000 2002 2004 2006 2008 2010 2012

$(000)

Yearly Performance

World Exports ofPest & Agrichemicals

World GDP'

S&P 500'

y = 0.7153x + 366651

R = 0.8743

$ -

$ 500,000.00$ 1,000,000.00

$ 1,500,000.00

$ 2,000,000.00

$ 2,500,000.00

$ 3,000,000.00

$ 3,500,000.00

$ - $ 1,000,000.00$ 2,000,000.00$ 3,000,000.00

WorldExportsofPest&

Agrichemicals

World GDP (coded)

Exports of

Pest & Agrichemicals vs Coded GDP (GLOBAL)


10/17

Competitive Environment (structure) in the Industry:

Competition is growing especially in low-cost, moderately regulated parts of the

world such as Asia, Middle East and South America.

The specialized nature of the business makes the threats of entry and price

competition minimal. There are significant barriers to entry associated with the

product such as: Government restrictions, licenses, quotas, and patents, high

technology and development requirements (high switching costs). Also, many of

the major competitors have significant economies of scale and their distribution

systems can be very complex because of the ample spectrum of available service

and support degrees they can offer. Whats more, the interaction of their use in

productivity of crops and their relatively inexpensive selling price allow them to

avoid the usual fate of commodity-like goods.

Finally, their suppliers are more often than not unable to exert much bargaining

power precisely because of the significant entry barriers this industry enjoys.

Consequently, while this industry, like any other, has enough rivalry to necessitate

the very best managerial talent and while that is coupled with a need to innovate

successfully, it has a low relative competitiveness.

Perhaps the biggest threat of all is that which the Government could impose on it

in the future.


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Company Specific analysis

SWOT Analysis6

Future prospects (10-k)

The company expects to continue to improve products through innovation and technology. They

also expect to grow their vegetable seeds business. Finally, they expect to better manage their

agricultural chemistry business as it matures globally. See MD&A for more detailed discussion ofsome of the opportunities and risks they have identified for their business.

Financial summary

The companys Net sales decreased YoY from 2009-2010 primarily because of decreased sales of

Roundup and other glyphosate-based herbicides in the U.S., Europe and Brazil. The principal

reason for this important decrease was the oversupply created by competition from generic and

other substitutes.

In terms of liquidity, the net cash flow was $564 million in 2010 vs. $1,523 million in 2009. They

also used less for acquisitions in 2010 than in 2009.

Its also worth noting that the company did have two repurchase programs, which tend to boost

the stock price and stockholder returns. They also reduced the amount of cash used for

6The factors for the SWOT analysis were adapted from the companys annual 10-K report to the Securites &

Exchange Commission (SEC).(Deloitte & Touch LLP, 2010)

Strengths:

Value-added pricing

Customer Support and serviceStrong market shares

Patents and other protections

Expansion into lower-cost,higher-growth regions

High Innovation

Geographic diversity

Weaknesses:

Aggressive Litigation

Low diversity of products

Not-so-low costs

Controversial business practice

Opportunities:

Further expansion Population growth

Climate

Reforming Image

Threats

Government and Cultural Restrictions Farmers who violate agreements

Harmful products

Land Shortage

MON


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acquisitions. Both of these proceedings tend to be safer industry practices that protect its

shareholders.

Finally, its bottom line (Net Income Margin) was reduced from 18% in the previous two years to

11% in 2010. This is possibly the worst news in terms of financial measures. Notwithstanding,

today its YTD performance in terms of Net Income Margin stands closer to 14% which isconsidered a healthy profit in this industry.

As seen by Monsantos SWOT and their own views of critical performance criteria the company is

employing a defensive strategic approach by investing in fixed assets and technology (Direct

Foreign Investment) to deflect the effect of the competitive forces. At the same time, it employs a

differentiation strategy by trying to give the best service and the most innovation. Also the

company expressed that it wishes to focus on innovation, client attention, and product planning.

This is backed by the increase in Research & Development and the Selling & Administrative

Expenses coupled with the larger decrease in cost of goods sold. That is, the company was able to

capture a premium without having an equally offsetting increase in selling and supporting costs.

Whats more, the managerial leadership seems to be very rational and implementing rational

planning as it has been restructuring operations in accordance with energy and other material

prices.


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Financial Analysis

Historical evaluation

The company seems to have prudent liquidity in terms of free cash flows. It doesnt however have

a large enough acid ratio (1.28). It has an above average (30% vs. 41.82%) Debt Ratio which it has

maintained rather stable. Its TIE Ratio is very high. By effectively using financial leverage thecompany is able to obtain an above average profit as indicated by the 10-year average

performance of its earnings per share, and Net Income percentage (18.57% and 19.16%,

respectively). Its asset management isnt very high, but this (13.59%) is normal in this industry.

Moreover, in most cases asset management in terms of Inventory Turnover, Days Sales

Outstanding, and other efficiency ratios has been improved over the ten years (generally reaching

an optimum in 2008). The most logical explanation for the optimum historical performance to

have happened in 2008 is due to the low energy prices. While its ROE is below industry average

(14.85% vs 17.9%) its financial risk position is stronger-than-average. (Shoucair, 2011)

The company has a Basic Earning Power of approximately 30.16%. This means that the company

can earn recover that percentage of the total assets value before deducting for taxes and interest

expenses.

Review of accounting methods

Company recognizes revenues when the product has been transferred; at this point there is no

right of return, performance has been met, and theres reasonable assurance of sale proceeds

(realizable). The company uses an allowance for doubtful trade receivables which is estimated

through experience of collection, economic and market conditions, and individual customer

account balances.

For the foreign currency translations, Balance Sheet numbers and accounts are translated at year-

end rates and the Income Statement transactions are translated at the average rate for the

statement time period.

Adjustments to Financial Reports:

The company adopted the Asset Retirement and Environmental Obligations topic of the Financial

Accounting Standards Board (FASB) Accounting Standards Codification (ASC) and, consequently,

recorded a cumulative effect of accounting change of $6 million aftertax.

They retrospectively adopted: 1)a FASB-issued standard that requires the two-class method of

computing earnings per share as described in the Earnings Per Share topic of the ASC; and 2) a


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new accounting guidance related to the Consolidation topic of the ASC (both effective Sept. 1,

2009).

Financial Projections

Listing of principal assumptions:

In order to use CAPM (which well use to calculate the required rate of return), we have to

assume that:

i. Investors are risk averse (positive relation between risk and return)ii. Systemic risk is the relevant risk (to calculate required return)

In order to use constant growth models we assume that:

iii. CFs (dividends, free cash flows, etc.) will grow at a constant rate, g (which weknow)

iv. Holding period is infinitev. Present Value of expected cash flows is discounted at required rate of return

In order to use relative comparisons wed have to assume that:

vi. Theres a justified P/E (or another) ratio that we can use as a multiple toobtain the estimate stocks fair price

Projected data:

Using growth rate estimates provided by Value Line (which according to several academicians has

been the most accurate approach) I project the following for Monsanto Co. for the 11/23/2011

close of market:

K=rRF + B(MRP7) = 1.88% + 1.03 (5.5%) = 7.605%

gD=5.5%

gEPS=7.5%

DPS1=DPS0(1+g) = 1.2(1+0.055)=1.266

EPS1=EPS0(1+gEPS)=3.14975

7Estimated from Survey of Academicians and Expert usage


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Application of Valuation Methodologies

Dividend Discount Model:

P-hato=D1/(k-gD) = 1.266/(7.55%-5.5%) = $58.68

Relative P/E Multiple:

P/E1=(D1/EPS1)/(k-gD)=18.69473

P-hat0E= P/ E1 x E1 = 18.69473 x 3.14975 = $58.89

Technical Analysis:

As seen in the technical graph (above) the DMAs have crossed over, as has the Slow Stochastic;

the RSI Signal for bullish trending has just fallen below zero and the important supports have been

broken. If a Fibonacci Retracement were plotted in the graph, wed see that the 68.9% level was


16/17

near $70.18. Thus, that is now the new resistance level. The technical analysis indicates that MON

should be sold or short sold.

Recommendation

Because Average Po

WACC) such as MON. Moreover,

because of the current macroeconomic conditions and how closely related this stock is to the

Global Economy, Id expect it to have a much better return from 2012-2017 and then diminish

thereafter.


17/17

Works CitedClive, J. (2010). Global Status of Commercialized Biotech/GM Crops: 2010. Ithaca, NY: The

International Service for the Acquisition of Agri-biotech Applications (ISAAA).

Deloitte & Touch LLP. (2010). 10-K. St. Louis: Monsanto Co.

Doll, B. (2011, November 21). Conditions Continue to Improve, but Risks Remain. Retrieved

November 23, 2011, from BlackRock Investments, LLC Web site:

http://www2.blackrock.com/US/individual-investors/market-insight/investment-

commentary/bob-doll-weekly-commentary

Loughlin, K., & Mock, T. (2011, November 22). Business And Financial Risks in the Commodity And

Specialty Chemical Industry. Retrieved November 23, 2011, from Standard & Poor's Financials LLC

Web site:

http://www.standardandpoors.com/prot/ratings/articles/en/us/?articleType=HTML&assetID=124

5306107682#ContactInfo

Reilly, F. K., & Brown, K. C. (2009). Investment Analysis & Portfolio Management, Ninth Edition. In

F. K. Reilly, & K. C. Brown, Investment Analysis & Portfolio Management, Ninth Edition (p. 410).

Mason, OH: South-Western Cengage Learning.

Shoucair, S. R. (2011). Monsanto Co. Full Research Report. New York, Ny: Value Line, Inc.

The Economist. (2011, Feb 23). The adoption of genetically modified crops. Retrieved November

23, 2011, from The Economist online Web site:

http://www.economist.com/blogs/dailychart/2011/02/adoption_genetically_modified_crops

Wardlaw, B., & Wong, A. (2011, October 27). Industry Report Card: Regional Growth Should BuoyDemand For Asia Pacific's Chemical Products. Retrieved November 23, 2011, from Standard &

Poor's financial Services LLC Web site:

http://www.standardandpoors.com/prot/ratings/articles/en/us/?articleType=HTML&assetID=124

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