Cash In on the Bull Market in Agricultural Commodities

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Jim Rogers, the famous commodities bull and George Soros' partner at the Quantum Fund in the 1970s, has once again declared a bull market in agricultural commodities. Amid a growing global population, especially in emerging economies, the United Nations projects that the world will need to double grain production by 2050 in order to keep pace with the population overload. This means outsized profits are ahead for nearly all companies associated with agricultural commodities.

Three companies that will benefit a lot from the bull market in agriculture are DuPont (NYSE: DD), ​Syngenta(NYSE: SYT), and ​Monsanto(NYSE: MON). Of the three, DuPont is the largest, with nearly $40 billion in revenues compared to about $13 billion for the other two competitors. DuPont is larger and has more diverse operations than Syngenta and Monsanto, but it is not necessarily the most efficient of the three. In fact, Du Pont regularly earns lower EBITDA margins than its smaller rivals.

<img src="/media/images/user_13490/ag-ebitda-margin_large.png" />

The same holds true for free cash flow; Syngenta and Monsanto regularly produce more free cash flow per dollar of sales than DuPont. This discrepancy is largely due to DuPont's non-agricultural businesses, which earn lower margins. However, some of the non-agricultural businesses earn higher returns on capital than the agriculture segment.

Which Is Cheapest?

Syngenta and DuPont appear to be cheaper than Monsanto based on current trading multiples of normalized pre-tax earnings and free cash flow. To get the normalized pre-tax figure, take the average of each company's pre-tax return on tangible invested assets since 2002 and multiply by current tangible invested assets. To get the normalized free cash flow number, take the average free cash flow margin from the last decade and multiply by the last four quarters of sales. If you do that for each company, you get the following multiples:

<img src="/media/images/user_13490/ag-trading-comps_large.png" />

DuPont looks the cheapest based on the pre-tax multiple, but Syngenta looks cheaper on the free cash flow figure. To understand why Syngenta is cheaper than DuPont, let's take a look at the companies' ability to convert EBITDA into free cash flow:

<img src="/media/images/user_13490/ag-ebitda-to-fcf-conversion_large.png" />

Over the last decade, DuPont and Syngenta have turned about the same percentage of EBITDA into free cash flow. Yet, you'll remember that Syngenta has higher EBITDA margins than DuPont because Syngenta's business does not require as much capex as DuPont's. This is because DuPont has expanded into a diversified array of capital-intensive businesses; Syngenta's operations are centered around seeds and pesticides, whereas DuPont's agricultural segment is only part of a much larger chemicals company. Many of the segments do not earn the same margins as the agricultural business. Thus, Syngenta will continue earning higher free cash flow margins than DuPont, even if both were to stop growing and simply use cash to maintain operations. Therefore, Syngenta looks cheaper than DuPont even at 20x normalized pre-tax earnings.

If you apply the normalized free cash flow figures to the current market valuations of DuPont and Syngenta, you'll see that DuPont should return close to 8% over the next decade while Syngenta will return closer to 10%. So, it looks like although the value gap has closed in recent years, there is still some value left on the table for investors who have yet to jump on the agricultural commodities bandwagon.

titans8904 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Monsanto Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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