You are on page 1of 17

University of Puerto Rico at Mayagez 23/11/2011

Prof. Ruiz

Gabriel Irizarry Prez 802-05-3704

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 into separate 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.

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

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.

Monthly Change in Composite Economic Indicators


120.00

Monthly Change

115.00 110.00 105.00 100.00 95.00 90.00

117.40 115.89 116.24 116.35 114.51 115.31 114.97 115.31 112.48 112.59 113.49 110.90 109.69 109.91 110.13 110.24 108.17 107.84 108.06 108.38 108.71 109.25 103.50 102.16 102.47 102.68 102.57 102.78 102.88 102.98 103.29 103.29 103.29

*Source: Conference Board

LEI

CEI

LAG

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.

Monthly Change in Composite Economic Indicators


1.00% 0.80% 0.60% 0.40% 0.20% 0.00% -0.20% -0.40% Monthly Change

*Source: Conference Board

LEI

CEI

LAG

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).

LEI & CEI/LAG


1.20 1.15 1.10 Ratio 1.05 1.00 0.95 0.90

*Source: Conference Board

CEI/LAG

LEI

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 Press release 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

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.

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

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 demand for their manufactured products as well as other trades). (Wardlaw & Wong, 2011)

According 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

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 they expect 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. 2. 3. 4. The Federal Insecticide, Fungicide and Rodenticide Act; The Plant Protection Act; The Public Health Service Act; and 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

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

Adoption of Genetically Engineered Crops in the US


100 90 80 70 60 50 40 30 20 10 0 1998 % of Genetically engineered Crop

Cotton Soybean Corn

2000

2002

2004 Year

2006

2008

2010

2012

*Source: U.S. Department of Agriculture

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 good future 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 percapita, population, and enter the expected number of countries it will be able to obtain above market returns.

Geometric 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%.

Yearly Performance
0 0 0 $(000) 0 1998 0 0 0 0 -1 2000 2002 2004 2006 2008 2010 2012 World Exports of Pest & Agrichemicals World GDP' S&P 500'

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.

Exports of Pest & Agrichemicals vs Coded GDP (GLOBAL)


$ 3,500,000.00 $ 3,000,000.00 $ 2,500,000.00 $ 2,000,000.00 $ 1,500,000.00 $ 1,000,000.00 $ 500,000.00 $$World Exports of Pest & Agrichemicals y = 0.7153x + 366651 R = 0.8743

$ 1,000,000.00 2,000,000.00 3,000,000.00 $ $ World GDP (coded)

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

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.

Company Specific analysis


SWOT Analysis6

Strengths:
Value-added pricing Customer Support and service Strong market shares Patents and other protections Expansion into lower-cost, higher-growth regions High Innovation

Weaknesses:
Aggressive Litigation Low diversity of products Not-so-low costs Controversial business practice

Geographic diversity

MON Threats
Government and Cultural Restrictions Farmers who violate agreements Harmful products Land Shortage

Opportunities:
Further expansion Population growth Climate Reforming Image

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 of some 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

The factors for the SWOT analysis were adapted from the companys annual 10-K report to the Securites & Exchange Commission (SEC).(Deloitte & Touch LLP, 2010)

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 is considered 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.

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 the company 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 yearend 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

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 we know) iv. Holding period is infinite v. 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 to obtain 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

Estimated from Survey of Academicians and Expert usage

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

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<P (price at close of 11/23/2011) under both valuation models presented this stock isnt a good investment today; it should be sold or sold short. Even though the company has excellent opportunities for growth, this stock is overvalued. This is common in heavily traded growth stocks (ROIC > 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.

Works Cited
Clive, 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/investmentcommentary/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 Buoy Demand 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 5324503381

You might also like