CTVA - Corteva Agriscience

[mwtorock]

Many Bayer/Dow/Dupont investors here are aware of this company. Corteva is a recent spin off from DowDuPont that focuses exclusively on agriculture. The combination of seeds and crop businesses of Dow and DuPont created a pure-play US based Agriculture Company. Majority of the revenue comes from seeds (55-60%) and crop protection (40-45%). There is a small digital business that does not provide meaningful impact to the top line yet but is a promising play into the next wave of innovations in agriculture.

 

US market is about 50% of the revenue for CTVA, and an unusual wet planting season this year is driving the cuts in 2019 guidance. Along with usual dynamics in a spin off, it provides us an opportunity to own a wide moat business at a good price.

 

 

Is it a good business in the middle of a trade war?

 

World population is about 7.7 billion as of now and is growing every second. By 2050, it is estimated that over 9 billion people will live on planet Earth. A lot of that population growth is in developing countries, including China, India, Indonesia, and Pakistan. With increase in income level and living standard in those countries, food demand growth will outpace population growth. Since land expansion is limited, most of the crop production growth is expected to come from higher yields and increased crop intensity. That is driving secular demand for seed and crop protection products from Corteva.

 

Trade disputes do not change global demand of crops but shift the demand from one country to another. For examples, there are three large soybean producers in the world: the United States, Brazil, and Argentina. When China restricted soybean imports from the US, it imported from Brazil and Argentina. At the same time, the US soybeans are finding new markets that used to import from South America. These trade disputes are not going to have long term impact on companies like Corteva who sells products globally. Of cause if there is a trade war between US and China or US and EU that cause trade flow to stop, it would likely take down global economy and dent the business of Corteva for sure. However it would be really hard to find any stock investments satisfying under that scenario.

 

After consolidations in recent years, it is an oligopoly in global seeds and pesticide business. Corteva, Bayer AG (which bought Monsanto in 2017) and ChemChina (bought by Syngenta AG in 2017) control $50 billion of the $100 billion global seed and pesticide market. Bayer and Corteva together control about 60% of the U.S. seed market. It is very difficult for anyone to enter the market and compete with these guys without investing years and billions into R&D and distribution (with no guarantee of success either). Regulations, patents, Germplasm, and long product development cycles also contribute to the high barriers of entry.

 

Notice that among the top players only Corteva is a pure Agriculture company? It could be a key differentiation in the competition in the long run. For example, Bayer and ChemChina acquisitions do not provide that much cost synergies, and they both have Ag and non Ag businesses to compete for capital and resources. Corteva on the other hand has sole focus on Agriculture with priorities of cutting costs, improve efficiency and productivity, and driving product innovation.

 

Corteva is also trying to build a customer/farmer central culture that focus on serving farmers’ needs, a different approach versus some competitor’s lawsuit tactics. I think good customer relation is the key to long term success of businesses and Corteva is on the right track. For example, when farmers decided to switch to short cycle corn this year, Corteva helped them by swapping seeds quickly to meet that tight planting window. Costs of doing businesses like that surely hurt profits in the near term, but it is worth it for building long term relationships with customers. In the future, when higher commodities prices give farmer more profits, Corteva should enjoy better pricing and better profits.

 

 

 

What is it with the weather?

 

At the beginning of 2019, US soybean ending stocks record historical high due to trade disruption, so the expectation was farmers would switch to corn for this planting season.  However, the cold, wet spring across US Corn Belt and all the flooding you read about on the news had a huge impact on corn planting. At the beginning of June 2019, only 67% of farmers planted corn crops due to wet weather, while at the same time last year, about 98% of farmers had done that. Farmers with remaining acreage mostly switched to short cycle corns, which are lower margin products for CTVA. Moreover due to the shortened planting season, a lot of farmers skipped applications of some crop protection products, which also reduced CTVA sales for 2019. So not long after becoming an independent company, Corteva needed to cut the guidance for FY2019.

 

 

 

How does the future look like?

 

The unusual wet weather is a temporary headwind and we cannot expect that to repeat every year. With the bad weather behind us, future looks bright.

 

In a normal environment beyond FY2020, management expects to grow revenue 1-2% higher than market growth, including 3-5% growth annually in seeds and 5-7% growth annually in crop protection. With multiple products launches, Enlist platform is expected to gain market share. More importantly it gives Corteva a clear path to trait independence, so after 2023 expiration of licensing agreement with Monsanto/Bayer, the company can save millions royalty fees (750m paid for last year). That will be a big boost to EBITDA. The company also started generating revenue from license Enlist traits, which will 1) provide high margin revenue and 2) help strengthen competitive position down the road because licensing will reduce likelihood of competitive new technologies from other companies in the future.

 

 

 

Can we get it at a good price?

 

To estimate normalized operating earnings, we can start with the reasonably conservative low end guidance of FY2019 EBITDA at 1.9B. Assuming North America business bounce back to 2018 level, we can add about 250m there. Management also expects to have cost synergies of another 200m in 2020, and from what they have achieved so far in cutting costs, I think it is reasonable. So FY2020 operating EBITDA looks like around 2.35B, subtract maintenance capex 250m and another 500m for payments related to pension and other liabilities, we get normalized operating earnings around 1.6B. With market cap around 20B, it gives 8% earnings yield.  Consider where the interest rates are and where the market is trading at, 8% is good to own a global franchise with wide economic moat. With return on capital more than 20%, the growth of that earnings yield will likely be more than 10% on average for the next few years. In fact if we consider all the new products, increased efficiency and productivity, royalty fee income, etc, the growth in operating earnings could be a lot more than 10%. Management has guided mid term growth target of 12%-16%.  Whatever the growth rate end up to be, the best part is we do not need to pay for that.

[glorysk87]

Good summary - two risks that should be noted though:

 

1) A portion of their sales are related to glyphosate. They sell both glyphosate the chemical in their crop protection segment as well as glyphosate resistant seed systems in their seeds segment. I'll leave it up to the individual to determine how much of a haircut (if any) should be applied for the risk of a glyphosate ban or regulation.

 

2) PFAS liabilities - these should be minimal but they do still exist and could be some impact

[dwy000]

Good summary. I've always liked oligopolies in slow growth industries.

 

A couple of things stand out (or questions)

- where do u get $250 of maintenance capex?  Thru 1H capex was $860mn.  Anything over maintenance should be adding to the top or bottom line and that's not showing up in the results or projections

 

- the $200mn of synergies is already included in their projection so I dont think you can add it again.  By the way, what are "synergies"?  They spun out not acquired something.  Isnt this just normal cost savings that should be done regularly?  And note it is on top of the $300mn+ (in 1H alone) of separation costs.

 

- always irks me when companies dont include cash flow statement in their press releases or discussion. With Amazon it is the first thing in the release even before revenues and earnings. There's usually a reason for it.

 

- you included market cap in your operating earnings multiple but not debt. Theres about $2.2bn of debt there and $150mn of interest expense on it.

 

- theres always weather issues. This is an ag company, you cant cross off weather as a one off.  Weather just happens and they never use it as a reason earnings were really good in the other direction, only as excuses why earnings were bad.

 

I like this industry and the company.  I just think its overvalued here and will wait until more normalized earnings are shown (good point on the lawsuits too)

[mwtorock]

- maintenance capex of 250m I got from management. they guided 650m capEx for next year, and they broke out 400m for growth and 250m for maintenance. On the growth part they will add to it if they see the need. Since I started with EBITDA 1.9B which includes 600m Depreciation, I need to subtract 250m for maintaining the business.

 

-200m cost synergies are from Dow and DuPont combination of Ag businesses, including consolidated brands, facilities, and staff. After the earnings call in August, CFO had a follow up call with analysts about modeling in the guidance. One of the things they shared was the targeted cost synergies of 200m in 2020.

 

-Cashflow was a topic in that call. It is very seasonal, but basically they should get most cash inflows in Q4. Q1-Q3 would not show any meaningful operating cashflow.

 

-They will utilize debt only on short term basis going forward (commercial papers, etc). Because the cash outflow in Q1, they borrow short term to fund working capital, and by year end they should get cash in-flows to pay the debt down. And they have 2B cash on the balance sheet too, so I did not take that short term debt into account for Enterprise Value.

 

-Weather is always an issue somewhere in the world. Last year it was Brazil and this year it was US. But Agriculture is very resilient as it always bounces back. This year it was great weather for farmers in Brazil. Another thing to note is how extremely wet it was this year for the US, and it should be considered as a year close to the lower bound of variation. Of cause, next year it could be something else, but over a long period of time like 10 years it should average out.

 

 

[Spekulatius]

I agree that $250M in Capex is too low. In the long run, this company has way higher earnings power. The reason is simple, CTVA currently pays $800M in Royalties for seed traits to Monsanto, a number that is supposed to go up to ~1B in 2022. The patents for these traits expire in 2022 and this means that royalties will start to go down. If Roundup get banned or used less before, it may mean that those roundup ready traits may become less dominant and perhaps royalties go down before. 2022. While this is a few years away, there seems to be a clear Lt catalyst to much higher earnings for CTVA. I believe the Morningstar stock reports discuss this to some extend.

 

Disclosure: no position, but would br a buyer again at $25.

[glorysk87]

I agree that $250M in Capex is too low. In the long run, this company has way higher earnings power. The reason is simple, CTVA currently pays $800M in Royalties for seed traits to Monsanto, a number that is supposed to go up to ~1B in 2022. The patents for these traits expire in 2022 and this means that royalties will start to go down. If Roundup get banned or used less before, it may mean that those roundup ready traits may become less dominant and perhaps royalties go down before. 2022. While this is a few years away, there seems to be a clear Lt catalyst to much higher earnings for CTVA. I believe the Morningstar stock reports discuss this to some extend.

 

Disclosure: no position, but would br a buyer again at $25.

 

Lol...I can't tell if you're serious. You're not a buyer here, but you'd be a buyer 4% lower?

[Spekulatius]

I agree that $250M in Capex is too low. In the long run, this company has way higher earnings power. The reason is simple, CTVA currently pays $800M in Royalties for seed traits to Monsanto, a number that is supposed to go up to ~1B in 2022. The patents for these traits expire in 2022 and this means that royalties will start to go down. If Roundup get banned or used less before, it may mean that those roundup ready traits may become less dominant and perhaps royalties go down before. 2022. While this is a few years away, there seems to be a clear Lt catalyst to much higher earnings for CTVA. I believe the Morningstar stock reports discuss this to some extend.

 

Disclosure: no position, but would br a buyer again at $25.

 

Lol...I can't tell if you're serious. You're not a buyer here, but you'd be a buyer 4% lower?

 

Yes, I am serious. I have gotten two round trips out of this stock from below $25 to above $28 already this year. I think odds are high that the stock will go below $25 again. I don’t mind holding either, but if I get a quick 15% return out of an apparently rangebound stock without news or fundamental changes, I tend to take it.

 

I try the same thing with FRFHF. Call it trading sardines with a value backstop.

[mwtorock]

In the short term, price certainly will fluctuate. Part of the reason we can get it at discount is that it is not in favor of investors yet. The earnings power is depressed or hidden rather as it went through the spin off process and ran into a nasty headwind in its largest market. The company is spending 1B+ on R&D annually. If it is no growth situation, how much of that could be put back to bottom line? Those investments for future business understate the earnings. 

 

Is this company a global franchise with sustainable competitive advantages? and is the industry growing or declining? and how is the barriers to entry?

 

The answers to those questions are positive to me.

[rogermunibond]

https://www.wsj.com/articles/roundup-ruled-the-farm-now-its-maker-has-a-challenger-11578328409

 

Enlist getting good press.  Plus dicamba seems to be creating another litigation nightmare for Bayer (B school case #3433433 in acquisitions are hard).

 

https://www.wsj.com/articles/bayer-basf-ordered-to-pay-265-million-in-weedkiller-crop-damage-suit-11581795711

[mwtorock]

https://www.starboardvalue.com/wp-content/uploads/2020-Active-Passive-Investor-Summit-Corteva-Inc-and-ON-Semiconductor-Corp..pdf

 

Sharks circling around...

[handycap5]

I'm old enough to be scared by the 100 or so companies that went bankrupt due to asbestos. The PFOA and AFFF liabilities scare me. Could someone who is more knowledgeable with the litigation risk here help me sleep at night?

[mwtorock]

Base case is Corteva pays about $1 -2 billion in PFAS-related litigation and cleanup expenses.

 

Guestimate of PFAS cleanup and litigation is around $40 billion or a little higher industry wide. Old DuPont (which includes today's DuPont, Corteva, and Chemours) might face 15% to 20% of that. DuPont and Corteva need to settle their arbitration with Chemours (maybe agree to pay half for example). Based on the DuPont and Corteva liability-sharing agreement, the two companies will split the first $300 million in PFAS-related costs evenly. For all expenses above $300 million, DuPont pays 71% and Corteva pays 29%, which could result in around $1 billion to 2 billion for Corteva.  Whatever the amount, it will be paid out in many years. It is not good from cashflow perspective, but not enough to force bankruptcy on CTVA in my opinion.

[mwtorock]

Good momentum in Q4 report and high guidance for FY21 - management on record saying 2.4-2.5 B EBITDA on sales 14.5B (3% growth). Not sure if they over promise due to activist pressure, but commodity prices are high and farmer income is $100+ more than last year per acer if lock in now, so there might be some truth in that confident guide.

 

https://s23.q4cdn.com/505718284/files/doc_financials/2020/q4/Q420_Earnings_Presentation_Slides_Final-Version.pdf

 

one thing keeps bugging me is that they have fx loss of 350m on BRL. i do not understand how come they just do not hedge it away. maybe they just under hedged...