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Two American Leading Stocks in the Agriculture Industry

October 17, 2013 | About:
When looking for long-term investment, I oppose to dividing capital between two competing firms in the same sector. While some individuals find the strategy as a safeguard against total losses, I prefer to choose complementing companies. I believe the strategy is more profitable in the long run, and market synergies can be absorbed more effectively. In this case, I will analyze two market leaders: seed and crop protection producer, Monsanto (MON), and agricultural machinery manufacturer, Deere & Co. (DE).

Developing and Caring Stock

Everyone in the agriculture business knows about Monsanto’s success story. It began with the introduction of weed killer RoundUp in 1976. Two decades later, the company diversified activities into genetically modified seeds, resistant to the weed killer. Both introductions were welcomed by farmers around the world as they saw total production costs decline. The trials done during the last two years and recent presentation to the market of Intacta RR2 Pro, is expected to live up to the firm’s history.

The Intacta RR2 Pro soybean trait is marketed as the first-ever insect-protected trait in soybeans. It has been specially developed for South American farmers, where two of the top three world soybean producers. This new product is an important evidence of the gap the company maintains opened with its closest competitors, even when forming temporary partnerships for joint research and development. Currently, the company holds a strong research and development pipeline, focused on drought-tolerant corn, phytophthora root rot soybean varieties, dicamba and glufosinate-tolerant cotton, insect protected and RoundUp Ready sugarcane, and herbicide-tolerant wheat, among others.

On the downside, RoundUp margins continue to decline, especially due to higher generic competition. Another spot on Monsanto’s future prospects is legal rumbles. In Europe, they have led to the firm’s unilateral decision to stop asking for genetically modified seeds clearance. In India, the introduction of genetically modified cotton seeds has been delayed in response to mass protests by farmers. Most importantly, Monsanto has recently lost its first legal contest against a farmer. This is a landmark for the firm and the seed industry as a whole.

Financially, Monsanto continues to improve and recently closed its third fiscal year in a row with 20% earnings growth year-over-year. Hence, it is not surprising that the two gurus with the largest holdings, Chris Davis and Steve Mandel, decided to sell some of their shares. I mean, the sale complete is a way to secure some winnings, since the closest competitor is two-million share behind. For the same reason, I remain bullish about Monsanto’s future prospects and expect new seed trait introductions to offset activities in the Eurozone. But, the stock currently trades at 22.4 times its trailing earnings, carrying an 82% premium to the industry average.

Planting and Harvesting Stock

While Monsanto provides the seeds and protects the plant, Deere & Co. manufactures harvesting machinery. Through the last year price increments and cost control policies have improved financial indicators. The company has, however, diversified a part of its activities into the construction and forestry segments. The strategy has thrown mixed results because while profitability increased, sales volume declined. In turn, net income and cash flow experienced improvements that allow management to carry out acquisitions.

In the U.S., proposed changes to the ethanol credit legislation would make the possession of credits mandatory. This in turn implies a higher demand for corn, and cash receipt. An underlying push for greater corn production, cereal and vegetable oils in general, is growing population. This phenomenon places an invisible pressure over farmers to produce more efficiently, and introduce the latest technology available for that purpose. The success of Monsanto’s Intacta RR Pro in South America can increase farmer’s disposable income, feeding future prospects for Deere & Co.’s agriculture segment in the region.

In the international scenario, Deere & Co. has replicated its U.S. business model: high resale value and solid support network. These characteristics have converted the firm into a world leader, but most importantly a leader in key developing markets and farming countries like Brazil and Argentina. Hence, even though the competition continues to fight, the battle is always won by the green machines. The Indian market also offers great opportunities for growth in the small horsepower tractor line. What is most concern at the international level to the firm is raising import tariffs at the Commonwealth of Independent States.

Financially, Deere & Co. is moderate due to debt increments and cash flow swings related to recent acquisitions. Currently trading at 9.5 times its trailing earnings, the stock carries a 16% discount to the industry average. And, the largest guru, Warref Buffett has made no changes to his holding since entering in September of last year. The two following gurus in size, Jim Chanos and Scott Black, have recently increased their holding and I share their optimism.

Timing and Profits

When looking at the price premium carried by Monsanto, it is hard to be convinced that buying stock at this point in time will be profitable in the long run. For this exact reason, I prefer Deere & Co. at the time because the market synergies generated by new seed traits will in part be absorbed. Additionally, the company continues to find new markets where it can expand operations, without the legal rumbles experienced by Monsanto.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanin Aegea
A fundamental analyst at Lone Tree Analytics

Visit Vanin Aegea's Website


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