We discussed Monsanto in a CotD post in late May, as the stock was breaking out to a new multiyear high. My conclusion:
Today’s breakout is an encouraging technical sign for the bulls. The fundamental story makes sense to us here. We’ll keep this stock on our watch list and see how it handles the breakout in the weeks to come, with a possible trade in the future if it retests the breakout in a healthy fashion.
Well, 2 months later, MON is back near the $117.50 breakout level:
However, since the late May post, two concerns have developed for MON, one fundamental and one technical.
Fundamentally, the fall in grains prices has been the main reason for the selling in the stock since the strong earnings report and gap higher in late June. MON actually rose 5% after beating revenue and EPS expectations on that report, but the earnings gap day marked the high of the year so far in the stock. Corn, wheat, and soybeans prices have continued to multiyear lows over the past month, however, as illustrated by the Bloomberg Grains index:
This severe fall in cash crop prices could lead to a fall in demand for MON products over the next year, particularly if grains prices remain down here.
Technically, as a result of the aggressive selling in MON in July, the stock has actually breached the $117.50 breakout level for the first time since mid-May. Sellers have become more aggressive than buyers near this technical pivot point, and MON is now exactly unchanged on the year.
Having said all of that, MON’s fundamentals are less correlated to grains prices than most of its agricultural products peers. The GS Research team recently laid out the risks for a potential multi-year agricultural industry downturn, with the following thoughts:
With crop prices near cost of production in many areas and farm income down 25% in 2014-2015, by our estimates, we expect significantly tighter farm spending over the next year.
Yet, the GS Research team maintains MON as a buy despite that overall view on Ag stocks because of the following rationale:
Monsanto (MON, Buy): We maintain our Buy rating on MON shares, where we expect a solid expansion in Seeds and Genomics growth in FY2015 as MON continues rolling out its blockbuster South American soybean product Intacta, extends its leadership position in Corn, and benefits from a new, more aggressive approach to its balance sheet with an aggressive accelerated share repurchase program. Moreover, as its smaller but more commoditized herbicide business flattens out, the quality of MON’s earnings stream improves and should help MON realize some catch up in its relative valuation multiple, which has lagged over the last several years despite terrific 20%-plus EPS growth. We recognize a weak Ag environment weighs on investor sentiment, but MON’s ability to drive another year of 20%-plus earnings growth even in the face of this poor sentiment should be rewarded, in our view. Our 12-month price target of $138 is based on 11x our FY2015 EPS estimate of $6.29.
Amidst both the technical and fundamental uncertainty in MON, we were surprised to see that 30 day implied volatility recently hit a 2 year low:
[caption id="attachment_43304" align="aligncenter" width="600"]
30 day implied volatility in MON, Courtesy of Bloomberg[/caption]
Options pricing looks cheap, but I don’t have a strong directional opinion. Fundamentally, the stock looks reasonably priced with good growth prospects and an admirable competitive moat, though the fall in grains is a concern. Technically, the chart looks like a failed breakout if MON closes below $117.50. The Sept 115/120 strangle is priced at around $3.60, which implies a break-evens of lower than 111.40 or higher than 123.60 on September expiry. Not exactly great risk/reward in my view.
For those who do have more directional conviction, the best trades are probably in October expiration, which captures the next earnings report. The Oct 120/130 call spread for around 2.00, or the Oct 115/105 put spread for around 2.40 both look reasonably cheap for those who want to express a directional view a few months out. As for me, I’d rather stay away given the conflicting signals.