A bumper harvest

This is one company on our list of outperforming stocks that perhaps needs no introduction. Monsanto — the world’s largest multinational seed company and the bane of seed nuts everywhere — has so far been hailed as much for its technological breakthroughs as it is reviled for its genetically modified (GM) crop practices. Once hailed as the company of the year in 2009 by Forbes magazine, Monsanto still managed to top Covalence’s 578-strong list of unethical companies in 2011. India is no stranger to this dichotomy. The global giant’s listed arm is currently present in the country in two agricultural verticals — the development, marketing and distribution of hybrid corn seeds under the brand name Dekalb and the sale of glyphosate-based herbicides under the Roundup brand. Another unlisted Monsanto subsidiary — a 50:50 joint venture with Mahyco — is engaged in the sub-licensing of Bt cotton seeds, a source of sustained controversy for the MNC. But it is the listed arm Monsanto India Limited’s dream run (up nearly 400% over the past year) that we are focused on. 

While the Sensex has coasted to a new high and delivered a 55% return over the past year, Monsanto’s stock price skyrocketed from ₹685 to ₹3,600 before correcting to around ₹2,800 in early October. Presumably, investors were discounting the ₹5-crore loss in Q2FY15, compared with a ₹76 crore profit in Q2FY14. Though analysts point out that Q2 is the weakest quarter for Monsanto, given kharif and rabi sowing usually happens in Q1 and Q3, the fact remains that the company’s numbers belied investor expectations at a time when competitor Kaveri Seeds did not disappoint. And, combined with the weak numbers, the resilient stock price hints at the possibility that perhaps Monsanto’s stock price has a life of its own, separate from the fundamental realities of the business. Which begs the question — what, then, has driven this exceptional outperformance?  

Not so corny

Let’s look at the fundamentals first. Dekalb currently holds the distinction of being India’s largest selling maize hybrid, with the parent company holding a 25% market share in the maize seed segment (see: Losing earth). New launches now contribute close to 40% of the company’s revenue, helping reduce the age profile of its portfolio from 10 years to eight years in the process; Monsanto’s target is six years. The company has found more success in states growing maize in the rabi season such as Bihar and Uttar Pradesh because of a robust rabi seed portfolio, as compared with states in the south.

Losing earth

Monsanto’s Dekalb now has 25% of the corn seed market from 39% in 2007

Notes a Motilal Oswal Securities report authored by Niket Shah and Atul Mehra, “Monsanto has a strong hold over the market in north India while southern kharif corn-growing states such as Andhra Pradesh, Tamil Nadu and central Karnataka have gone over to other competitors. The management plans to aggressively roll out newer hybrids for kharif going forward, [a strategy that] has been under development from the past three-four years, thereby helping improve its market share position.” Monsanto’s competitors in the southern states include Hyderabad-based companies Nuziveedu Seeds and Kaveri Seeds, which hold around 25% market share between them. 

Most rabi hybrid seeds are single-crossed and thus high-value and low-volume, unlike kharif seeds, which are either two-way or three-way crossed, making them low-value and high-volume by nature. Sageraj Baria, analyst with East India Securities, explains, “Hybrids are developed by crossing high-yield international seeds with Indian seeds and adjusting for Indian agro-climatic conditions. Single-cross seeds are of the best quality and provide a higher yield from the farmer’s point of view. The yield drops in two-way and three-way crosses. Hence, farmers are ready to pay a premium for single-cross seeds.” Says Niket Shah, analyst with Motilal Oswal, “There is a significant shift towards single-cross hybrid corn, which has a much higher Ebitda margin of 35-40% and is priced two times higher than other hybrids. New product launches in FY14 have 30-35% higher average selling prices and 5 to 7% higher margin than older products.” 

Over the past two years, Monsanto has launched several such single-cross hybrids, with these seeds now accounting for 40% of Monsanto’s seed portfolio. The launch of three additional single-cross varieties in FY15 and the trend of increasing acreage (see: A’maize’ing crop) is expected to drive up sales of single-cross hybrids, thereby providing a significant fillip to the company’s margins. In addition, the management expects a lucrative rabi season for corn once flood waters recede in Bihar, leaving moist soil in their wake. “Due to a decline in volumes in Q1FY15, the company expects corn prices to bounce back and this should drive acreages higher. The mix of single-cross seeds is also expected to improve gradually from the current 50%, which will drive margins higher,” says the Motilal Oswal Securities report.

A’maize’ing crop

Monsanto, with a strong presence in the north, stands to gain from steadily increasing rabi maize acreage

In addition, Monsanto claims that there are hefty gains to be made from spiraling demand for corn in the future. The company, in its FY14 annual report, notes, “The demand for corn as poultry feed, which constitutes about 50% of demand, will continue to grow at a robust rate of 8-9% annually. In addition, demand for corn in the starch industry is also expected to grow in the near term. Various reports estimate that the total production of maize in India will touch the 30 million tonne mark by 2020, and double by 2022, with demand outstripping supply.” But the company also admits to risks on the demand side in its corn seed business due to a proliferation of competing products. “Due to competitive marketing schemes and a constant stream of new products, farmers and trade channels have more choice than ever before.” So far, the company has been successful in managing its inventory and estimating demand for its products. Inventory management is one of the most important facets of the corn seed business because of the low shelf life of the product — corn seeds last for only about a year, compared with the three-year shelf life of cotton seeds. 

Shah in his report states, “All corn companies need to have around six to nine months of inventory at the start of the season. If the inventory comes back from trade channels and distributors, almost 50-70% of the inventory won’t germinate, leading to companies taking a write-off on the same. To gain greater operational efficiencies, then, Monsanto decided to consolidate its seed-processing operations at Hyderabad, from the earlier Bellary and Eluru. This has resulted in better operation controls, inventory management and reduction in operational costs.” These measures have also helped the company reduce write-offs to under 7% of revenue, from an average of 20% in the past three years. 

But Monsanto’s key differentiator in the competitive Indian market is the immensely successful Monsanto Farm AgVisory Services that it launched in 2010. As part of this service, farmers can obtain crop management advice from nearly 40 Mumbai-based agro experts by simply dialing a toll-free number. So far, the company claims to have reached out to nearly 1 million farmers across 16 states using this service, which is available in seven languages. Analysts say the company has invested heavily to develop the service and foster deeper brand loyalty among its target audience. It is a unique service whose replication is difficult and would need extensive field work, investment and research. “Companies such as Pioneer tried to replicate this model through outsourcing but have been unable to get a breakthrough,” says Shah. Besides, Monsanto enjoys the advantage of being present in the Indian market almost since independence; it entered the country in 1949. “Their relationship with farmers is consequently better. Loyalty and trust are major factors in this business,” adds Baria. 

Pests under control

Unique circumstances on the rural front also portend a brighter future for Monsanto’s agrochemical vertical. The company invented glyphosate, the underlying chemical used in its marquee herbicide Roundup, in 1970, though the patent on it expired in 2000. Since then, Chinese companies have flooded the market with cheaper replacements, grabbing nearly 40% of the global glyphosate market from Monsanto. The company has maintained a hold on the herbicide market with Roundup, however, controlling nearly 30% of the global market. The company is primarily involved in the business-to-business (B2B) distribution of herbicides to agricultural co-operatives, distributors and independent dealers. Shah mentions, “Monsanto’s production process experiences lower lead times and cost savings due to vertically integrated supply chains for raw materials.” The company leases phosphate mines from government entities for uninterrupted supply of stock. 

India’s usage of agrochemicals — broadly categorised as insecticides, pesticides and herbicides — is a fraction of that by developed countries (see: Random spraying). Of course, it helps that herbicides make up for a measly 20% of the total agrochemicals consumed in the country, compared with the global average of 48%. Analysts believe this macro factor will drive the company’s growth. “Average agrochemical consumption in India is 0.7 kg per hectare, compared with a global average of 3-4 kg per hectare. The potential is huge,” says Baria. Then, Roundup is perceived as a premium product and sells at a higher price (₹340 per litre) than products of competitors (₹310-320 per litre). In spite of the difference in pricing, glyphosate usage has increased multi-fold from 4.4 million lbs (2 million kg) in 2000 to 57 million lbs (26 million kg) in 2010, accounting for around 70% of herbicide sales in the country. This is due to under-penetration of agrochemicals in India as well as evolving labour patterns. 

Random spraying

Herbicide consumption accounts for one-fifth of all agrochemicals usage in India compared to nearly half globally

Traditionally, weeding on Indian farms was a labour-intensive task requiring the employment of a veritable army of farmhands. However, widespread urbanisation and state-led job entitlement schemes such as the Mahatma Gandhi National Rural Employment Guarantee Act have contributed to a rise in rural wages and popularised the use of herbicides as an economical alternative. Analysts also expect Monsanto to benefit from the introduction of RR Flex, its genetically modified, herbicide that will allow farmers to blanket spray cotton fields with Roundup, thus also aiding Monsanto’s herbicide sales (see: Shifting ground). Presently, herbicides can only be sprayed on the base of the cotton plant. “We expect RR Flex to enter the market in the next three to six months,” says Shah. 

GM at play

Needless to say, Monsanto is financially rock-solid. It has zero debt, good earnings quality and hence a sustainable dividend, an RoCE of 42% in FY14 and a net profit margin of 21%. The stock also witnessed strong FII interest in the recent past, with the FII stake going up to 2.18% in the September 2014 quarter from 0.25% in the March 2014 quarter. It has very low floating stock (parent holds 75%), which may have played a part in the sharp increase in the stock price. “It is important to remember that MNC stocks are usually traded at a huge premium,” reiterates Baria.

Shifting ground

Despite low penetration and rising rural wages, Monsanto gets 35% of its revenues from herbicides

Though it’s compelling fundamentals make Monsanto an investment worth considering, is the stock overvalued at its current price? (see: King of the hill) It is currently trading at a P/E ratio of 40X, compared with 21X for Kaveri Seeds and 29X for Rallis India, both of which operate in the same segments as Monsanto. The company is trading at 34X its FY15 earnings and 27X its FY16 earnings, compared with 22X and 17X for Kaveri. Also, its climb curiously coincides with the announcement of certain GM-related regulations. However, Shah maintains that Monsanto’s price run is mainly driven by fundamentals. “The company has almost doubled PAT from ₹67 crore in FY13 to ₹123 crore in FY14. In addition, it is set to gain market share over competitors because of new product launches and other advantages; it spends an unparalleled 4.7% of revenues on R&D and has access to the global germplasm bank thanks to its parent,” he adds. However, Shah concurs that a favorable GM regime might lead to a significant re-rating for Monsanto. 

King of the hill

Investors are more than willing to pay a high multiple for Monsanto’s grip on the seeds business

In February 2014, the then UPA government’s environmental minister, Veerappa Moily, approved field trials of nearly 200 GM varieties of rice, wheat, castor, mustard, brinjal, cotton, maize and many others. Monsanto’s stock price hit the roof in response, jumping from ₹1,333 on February 26 to ₹1,713 on March 4. And it had company — another GM player, BASF India, saw its stock price zoom from ₹651 to ₹784 over the same time period. Investors are also banking on such approvals resulting in the commercialisation of GM crops in the future, leading to windfall gains for such companies. “With approvals, these companies can start field trials for GM crops, opening up new growth avenues.

Monsanto, Syngenta, Pioneer and Dow had all been working on field trials for different crops before the imposition of a moratorium by the government and hence are much ahead of competitors,” points out Shah. Regarding the regulatory approval status of GM maize trials, the company says, “After securing necessary regulatory approvals, Monsanto has planted BRL–I trials, monitored by the Review Committee on Genetic Manipulation and BRL–II trials, monitored by the Genetic Engineering Approval Committee. These trials are done by State Agricultural Universities.” On November 26, the reigning NDA’s environment minister Prakash Javadekar said there was no ban on field trials of GM crops, following which the stock price jumped 4.5% from ₹2,792 to ₹2,918. As of December 5, the stock is trading at ₹3,183. 

However, there is severe opposition to GM crops in the country, not only among activists but also among influential organisations seen to be close to the ruling BJP-led NDA government today. The Rashtriya Swayamsevak Sangh’s economic wing, the Swadeshi Jagran Manch (SJM), is committed to economic nationalism and eschews the idea of multinational companies gaining control of the Indian seed industry. Contrary to his current stance, Javadekar had reassured SJM in late July that GM field trials had been put on hold. 

Scientists are also dead against the idea of commercialisation of GM crops before a competitive regulatory system performs comprehensive safety tests to assess their environmental and human impact. “There are many safety issues. Animal studies have shown that eating GM foods can cause laceration, immune system failure, lesions and retardation. However, whenever studies with negative results are released, Monsanto immediately claims it has not been performed properly,” says Suman Sahai, founder of Gene Campaign. 

The argument that is used to refute the potential toxicity of GM foods is that GM crops have already been commercialised in countries such as the US, Canada and Brazil and there has been no resultant damage to humans. “There is no study citing any harmful effects of consumption of biotech food in a peer reviewed journal. Such studies can be attributed to handful of largely discredited ‘experts’ — most of whom are public policy advocates rather than genuine scientists,” states Monsanto India. “Billions of meals from or derived from agri biotech products have been consumed globally. Biotech food has also been safely cultivated and consumed across the world, including tomato (China), papaya (USA, China), corn (16 countries), and squash and zucchini (USA). More than 300 million people in north America have been consuming genetically improved maize and soya in trillions of meals for over 15 years but there has not been a single substantiated case of harm,” the company adds. 

The opposition to GM crops is not limited to activists like Sahai and farmer organisations; many state governments, including the BJP-led states of Gujarat and Madhya Pradesh, are also opposed to field trials. The current law demands that Monsanto acquire a no-objection certificate (NOC) from state governments in order to carry out field trials, making their consent all-important to the company’s future growth prospects. Presently, except Maharashtra, almost all other states are against the idea of granting NOCs to Monsanto. “If the BJP manages to win over all the states, state BJP governments will simply comply with the centre’s diktat,” says Sahai. 

Monsanto has taken cognisance of these factors in its last annual report. “The regulatory risks relate to changes in government policies (including regulatory policies relating to both GM and chemicals) and interventions. Other such risks include the adequacy and efficiency of Central and state government support for agriculture,” the management says. It is tough to track the future trajectory of Monsanto’s stock, given the contribution of both favourable sentiment and solid fundamentals to the company’s galloping stock price. “GM will be the game-changer for Monsanto. The process of developing GM crops requires a lot of R&D and is both time-consuming and expensive. In this, it is way ahead of its competitors,” sums up Baria. At present, the company can only hope that investors don’t baulk at the prospect of future regulatory delays and a long wait for successful field trials. For, the alchemy of genetic modification currently holds the key to Monsanto’s fortunes in the 21st century.