A Stealth Agriculture Play
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
At a recent conference, Monsanto (NYSE: MON) CEO Hugh Grant raised earnings guidance, causing the stock to trade up in the subsequent sessions. Specifically, Grant commented on strong seed sales, confirming that more acres of corn were planted in North America and Europe.
Although Monsanto reported a strong quarter on April 4, there was concern at the time that much of the beat was due to the earlier start of the planting season, not organic growth. With the planting season complete, Monsanto confirmed that more acres were planted in North America and Europe and that the stronger than expected sales were due to business strength and momentum and not the timing of a historically earlier planting season.
When looking for derivative plays on Monsanto's strength, many investors turn to fertilizer names like Potash (NYSE: POT) or CF Industries (NYSE: CF). While these companies should benefit from an increase in corn acreage (the simple argument being more planted acres require more tons of fertilizers), Monsanto's business differs materially from the fertilizers, and I am hesitant to recommend them on the back of Monsanto's strength.
Monsanto's business is best characterized as an agriculture-technology business (they genetically engineer seeds to resist their insecticides and herbicides) while the fertilizer companies are largely commodity companies whose earnings are subjected to supply/demand dynamics. While increasing acres could increase demand (it also could not as farmers to choose to use less fertilizer per acre), a comparable increase in fertilizer supply could wipe away any anticipated gains from the demand side. Hence, one should not buy fertilizer stocks on Monsanto's strength unless one has a clear picture on the supply of the commodities.
A better way to play strength in Monsanto is through DuPont (NYSE: DD). DuPont is best known as a chemical company; however, 24% of DuPont's revenues and 29% of pretax operating income come from its agriculture business. Moreover, DuPont's Agriculture business operates largely in the same businesses as Monsanto -- seeds (representing 68% of DuPont's Ag sales), insecticides, and herbicides. Thus, one can look to strength in Monsanto's businesses as a tell on DuPont's future earnings.
Comparing DuPont's comments on its April 19 earnings call with Monsanto's, we are able to draw many parallels. First, like Monsanto, DuPont's agriculture segment reported strong numbers with sales up 16% and earnings up 18% year over year. Also, DuPont estimated that around $0.03 of the earnings was pulled forward from next quarter (Monsanto gave similar guidance while not giving a specific number). The only difference in the reports is that Monsanto raised its guidance for the full year on the call while DuPont held off.
It is important to note that DuPont reported around two weeks after Monsanto. In these two weeks, DuPont could have gained more clarity into how the planting season was wrapping up and decided not to raise their guidance for a reason. I, however, think that the company left itself some flexibility in case it saw weakness in some of its other product lines.
In summary, I would look to play strength in Monsanto with DuPont, not fertilizer names. Specifically, I believe that DuPont overestimated the amount of sales pulled forward by the early planting season, and I think they will see continued strength through their second quarter. I expect the company will either raise guidance or beat their current estimates.
dtlly has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services recommend PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.