Monsanto

Monsanto

Annual Report - Monsanto India - 2009-2010

MONSANTO INDIA LIMITED

ANNUAL REPORT 2009-2010

DIRECTOR'S REPORT

To
The Shareholders,

Your Directors have pleasure in presenting their 60th Annual Report
together with the Audited Accounts for the year ended 31st March, 2010.

Monsanto India

Investors with a two-three year horizon can buy the stock of Monsanto India, a leading producer and marketer of agricultural inputs.

From being a leading player in the agrochemicals business — which is subject to high competition and pricing pressures — Monsanto India has increased its presence in the lucrative hybrid seeds business, targeting crops such as corn, cotton and oilseeds.

The market for hybrid seeds offers potential for strong revenue growth and high margins.

Access to the research efforts and brand portfolio of the parent, which is a global leader in seeds and traits, is a strong competitive advantage in a business where investments in R&D and the gestation period to develop new strains, present the key entry barriers. At the current market price of about Rs 1,594, the stock trades at a price-earnings of about 14 times its estimated earnings for FY09.

This appears justified, considering the high domestic growth potential of the seeds business, the premium valuations enjoyed by life-sciences companies globally and Monsanto’s strong balance-sheet. Any decline in stock price to Rs 1,400-1,500 levels linked to broad markets would present an even better opportunity to add the stock to your portfolio.

Given the relatively low trading volumes in the stock, timing your purchases carefully may be necessary to maximise returns.
Restructuring for focus

After managing a consistent year-on-year growth in both sales and profits in the five years to 2004-05, Monsanto India saw its growth rates falter over the next two years, as it dramatically restructured its business. It forged a gradual exit from the more competitive and price-sensitive segments of the herbicide business and re-aligned its portfolio more closely with that of the parent — which is focussed mainly on seeds and traits.

Monsanto divested its Leader herbicide in 2006 and herbicide brands such as Machete, Lasso and Fastmix (Butachlor and Alachlor) in 2008. Profits of Rs 45.8 crore from some of these divestitures in 2007-08 significantly bolstered Monsanto’s net profit; this was distributed to shareholders through a special dividend of Rs 180 per share in 2008.
Cashing in

This restructuring has left Monsanto with hybrid seed brands — Agrow and Dekalb — and the Roundup herbicide business, all of which are leading products in the parent’s portfolio.

Over the past year, specific focus has been placed on Dekalb corn hybrids where Monsanto’s seeds target traits such as higher yield, oil content and longer shelf life. Corn is a very lucrative target crop in the Indian market and allows seed marketers to charge a significant price premium. Rising global prices for corn spurred by bio-fuel related demand and increasing use of corn by the food processing and animal feed industries has led to strong export as well as domestic demand for Indian corn.

High prices, combined with a short cycle, make corn an attractive cash crop for the farmer, paving the way for rapid adoption of hybrids (40 per cent of planted area) in the domestic market. Monsanto already claims a 39 per cent share of the corn hybrid market in India and hopes to further increase its share by targeting new regions (Northern states have lower rates of hybridisation than the southern ones) and traits.

In this respect, access to the parent’s product and research library lends a significant edge to Monsanto over other domestic players. Expansion in other target crops such as cotton and soybean also offers growth potential.
Better mix

The changed profile has left Monsanto with a business that is less import-intensive and volume-driven; with significant scope for improvement in profit margins (currently at 24 per cent).

The strong growth in the seeds business has already made up for recent divestitures; with the company recording profits after tax (leaving out exceptional items) of about Rs 64 crore in 2007-08, on sales of Rs 384 crore, re-establishing the earlier growth trajectory.

High margins and strong operating cash flows in recent years have ensured a zero-debt status for Monsanto India, with the company not taking recourse to any infusion of capital — either equity or debt — over the past ten years. This provides further justification for a valuation premium for the stock, in the current scenario of tight credit and rising interest costs.
Risks

The key risks to investors in the Monsanto India stock arise from the regulatory and weather-related risks that characterise the seeds business. In this context, the controversial Bt Cotton business, which Monsanto is usually associated with, is not part of the listed entity and is vested in a separate joint venture. Several MNCs in the agrochemical space have sought to delist their Indian arm. Such a move remains a possibility for Monsanto India as well. The Indian arm could also be impacted by any strategic decisions taken by the parent.

A recent move by the global parent to transfer the rice, sunflower and millet seeds businesses to an acquirer — Devgen — has seen Monsanto India also exit these crops in India. However, the more lucrative corn, cotton and soybean crops remain in the company’s fold.

Monsanto: Buy

Investors with a long investment horizon can consider exposure to the Monsanto India stock at the current price levels of about Rs 1,400. Though the company's recent financial performance has been unimpressive, long-term prospects for the domestic seeds business, on which the company is now refocusing, are bright. Given that the business is research-driven and technology intensive, entry barriers to the business are high, translating into good growth prospects for entrenched players such as Monsanto India.

The recent listing of Advanta India, which has a global presence in the seeds business, is also likely to lend greater visibility to this business, on the bourses. The growth prospects for the conventional herbicide business, though modest in the near-term, also appear stable for players such as Monsanto, given the robust product pipeline and the focus on premium, less price-sensitive segments of the market. The Monsanto stock trades at about 14 times its trailing 12-month earnings per share.

Seeds business

Though crop protection, with a focus on herbicides, has traditionally been the key revenue driver for Monsanto India, the company has been increasing its focus on the hybrid seeds business over the past couple of years. The seeds business accounted for 53 per cent of Monsanto's sales in 2005-06, up from 21 per cent five years ago, while the contribution of the herbicides business fell from 65 per cent to 31 per cent. The increasing shortfall of key food and commercial crops, the rising pressure to step up farm productivity (Indian yields of most crops are far below global averages) and the economics of adopting high-yielding seed varieties for the farmer are the demand drivers for high-yielding seeds.

However, plant breeding (developing new seed varieties) is a specialised business that involves a fairly long gestation period and calls for considerable research strengths and access to proprietary germplasm. In this respect, the backing of Monsanto India's parent — Monsanto US, a global leader in the seeds and traits business, and the latter's strong product pipeline — is a strong positive for Monsanto India. Monsanto India currently markets seeds in India under the Dekalb brand name (a global brand) and focusses mainly on maize (corn).

The demand growth

The demand for maize in the Indian market has consistently raced ahead of available supplies. Going forward, the demand growth for corn is likely to be strong on the back of expansion in the organised poultry industry and the growth in corn-based snack foods and starch-based industries. Though adoption of hybrid maize seeds has sharply increased sharply in the Southern States, considerable potential for hybridisation exists in the Northern states, where about 70 per cent of the maize acreage is still under conventional varieties.

In the herbicides business, Monsanto has traditionally focussed on branded specialty products through well-recognised brands such as Leader, Roundup, Machete and Fastmix. However, price competition in this business is high, with several domestic players emerging as low-cost manufacturers of agrochemical formulations. Since the profitability of new products tends to wane quickly after the initial years, success in this business depends on a robust product pipeline and a steady stream of launches, apart from the company's brand equity.

Though Monsanto is well-placed on this front on account of its global product pipeline and focus on commercial crops and food grains, it is not immune to price competition. This appears to be the key reason for the company's recent sale of its Leader herbicide business to Sumitomo and its increasing focus on the seeds business.

These rationalisation efforts also explain the company's unimpressive financial performance in recent quarters, after a steady pace of earnings growth in earlier years.

However, only investors willing to wait for two-three years should invest in the Monsanto India stock now.

The final quarter of the financial year is usually a poor one for agrochemical companies such as Monsanto India, given the seasonality of the business. Moreover, though long-term prospects for its businesses are bright, the company's near-term financial performance could be modest on account of the ongoing shift in business focus and the restructuring efforts.