Monsanto (MON) surged by 5% to $126.7 on Wednesday’s trade after the company reported modest third quarter results, but guided for a robust year. There were also positives in terms of the company’s long-term plans and this article discusses the results, the guidance and the earnings growth drivers for the next few years.
Third Quarter Result Overview
For 3Q14, Monsanto reported flat revenue of $4,250 million as compared to 3Q13. The company’s EPS however was lower by 2.4% to $1.62 in 3Q14 as compared to $1.66 in 3Q13.
The company’s EPS was dented by higher operating cost with the company investing in precision agriculture and biological platforms. The EPS was also impacted by the company’s R&D expenditure as a percent of sales increasing to 10% in 3Q14 as compared to 9% in 3Q13.
Therefore, both the factors negatively impacting the company’s near-term EPS are likely to have a positive impact on the company’s long-term growth and margin. For the same reason, the markets did not react negatively to a decline in margins.
Strong Guidance For FY14
The third quarter results have nothing to offer in terms of big positive or negative surprises. The positive reaction by the markets was largely driven by the company’s near-term and long-term outlook.
The first positive factor was the revision on the annual EPS guidance. Monsanto increased the full year earnings forecast range to $5.1-%5.2 per share from the earlier forecasted $5.0-$5.2 per share. In relatively challenging market conditions, the upward guidance is a major positive. The company also increased its full year free cash flow outlook to the upper end of previous guidance, at $700 million to $800 million.
Also, the company seeds and genomics segment reported a margin revenue decline for 3Q14. However, Monsanto expects the segment to drive the company’s full year gross profit. The segment is also likely to be one of the key long-term growth drivers for the company.
Positive Change In Capital Structure
Along with the results, Monsanto also announced a new two year $10 billion share repurchase authorization, allowing for $6 billion accelerated repurchase program. Apart from using the cash, the company also intends to use leverage for the accelerated repurchase program over the next 6-12 months.
The obvious advantage of the repurchase program will be a positive impact on the EPS over the next two years. However, by using debt for repurchase, the company also intends to change the net debt to EBITDA from a negative of 0.4 in FY13 to 1.5 by 2015. In a low interest rate environment, the company has a good strategy to lower the weighted average cost of capital.
Long-Term EPS Target Achievable
Another positive announcement for the long-term is the company’s plan to double the ongoing EPS by 2019. This is an ambitious plan and the company expects to deliver more than $4 billion of gross profit from the core seeds-and-traits engine.
I believe that Monsanto will be eying strategic acquisitions over the next five years in order to achieve this target. The company’s key strategy to achieve this target includes market expansion and continued trait upgrade. The market expansion and increasing global footprint is likely to be fuelled by inorganic growth. A low leverage provides Monsanto with enough financial flexibility to fund the organic or inorganic growth.
In addition, Climate Corporation, which was acquired by Monsanto in 2013, is expected to be another EPS growth driver for the company.
The Climate Corporation aims to help farmers around the world protect and improve their farming operations with uniquely powerful software, hardware and insurance products. There is a big opportunity for these products in the emerging markets and Monsanto, with its leadership position, can tap the big opportunity. Monsanto expects the potential market for the corporation platform to be in excess of one billion acres. Once this potential is tapped into, the company’s EPS growth target is likely to be achieved.
Monsanto’s stock has risen by 26% in the last one year as the company continues to perform well in challenging conditions. The company’s latest results have provided more insights on the company’s growth direction and the current plans have been taken positively by the markets.
Monsanto has some big growth opportunities like to Climate Corporation and the untapped emerging market potential. The company is likely to explore more inorganic growth options to boost its EPS over the next few years. With a strong balance sheet, the company is well positioned to do that.
In addition, Monsanto also offers a dividend yield of 1.4% and dividends are likely to grow over the next few years with EPS expansion. Considering all these factors, the stock looks attractive at current levels and can be considered for the long-term.