Everyone must eat to survive. As the population grows and development increases, there is less land to cultivate the rising amount of food required to feed the population. Investors who act now have the opportunity to acquire food production companies at prices roughly equal to the average valuation of the broad market. Fill your plates with these stocks.
While there are a plethora of seed companies, the top three — Monsanto Company (NYSE:MON), E I Du Pont De Nemours And Co (NYSE:DD), and Syngenta AG (ADR) (NYSE:SYT) — generate approximately 74% of the total sales volume. The research that these businesses produce allows them to develop seeds that produce plants for high crop yields and pest, drought and disease resistance.
Research is expensive, and the largest businesses can spread this cost across a much broader base of products and sales than smaller competitors. By starting our analysis with the three largest businesses in the industry, we have achieved our primary objective of finding safe businesses in a crucial industry, and will now identify the businesses that present the most attractive investment opportunity.
Is the biggest the best?
When Jack climbed up the beanstalk and found a giant, it was probably named Monsanto Company (NYSE:MON). Monsanto is truly the giant of the seed industry with 27% market share. The economies of scale realized by Monsanto have allowed it to produce net margins averaging 15.3% over the last 5 years, fully 22% higher than its next closest competitor, Syngenta, at 12.5%.
The stock in not cheap, sporting a price to earnings multiple of 19 times projected 2014 earnings. However, the high multiple is mitigated to a great extent by the anticipate earnings growth rate of 12.70% annually for the next five years. Return on equity, at 17.4% annually for the last five years, is exceptional for a business of this size and deserves an appropriate valuation premium.
Paying a premium price for a business this critical to human survival makes sense but buying Monsanto at just slightly above the market average P/E is a steal. When the dividend yield of 1.49% is added to the forward earnings growth rate of 12.7%, the 2014 P/E multiple is actually quite reasonable.
The second largest is not second best
E I Du Pont De Nemours And Co (NYSE:DD) is the second largest seed manufacturer in the world, with 17% market share. The 13 price-to-earnings ratio on 2014 projected earnings is well below that of Monsanto Company (NYSE:MON), but so is the five year projected earnings growth rate at only 8.4% per year. Couple that with the past five years’ income growth rate of -3.77% and cause for concern is present.
E I Du Pont De Nemours And Co (NYSE:DD) has failed to deliver with a sales growth rate of only 2.87% over the last five years. In addition to weak sales growth, the five year average net margins for E I Du Pont De Nemours And Co (NYSE:DD) have been a meager 7.7%, by far the lowest of the three. Even with a very respectable five year average return on equity of 28.9% and a 3.23% dividend yield, it’s hard to consider this business in the same class as Monsanto or Syngenta.
Second best is not too bad
Syngenta AG (ADR) (NYSE:SYT) may be the third largest seed producer in the world, but it is certainly no third rate competitor. There are some real advantages to not being the largest business in this industry: Monsanto Company (NYSE:MON) takes the brunt of high profile attacks on genetically modified seeds and other controversies. While the many of these attacks are unsupported by research, they do create public relations problems that Syngenta AG (ADR) (NYSE:SYT) is happy to avoid.
Syngenta AG (ADR) (NYSE:SYT) holds a 9% market share in the global seed business and pays a dividend yielding 2.58% that has grown at an annual rate of 23.26% for the last five years. With a projected earnings growth rate of 8.9% per year for the next five years and shares trading hands at only 13.5 times next year’s projected earnings, this is a business that would be fairly valued in just about any industry but is just plain cheap here. Adding in five year average net margins of 12.5% and return on equity of 22.5% and this is a world class investment poised to deliver annual total gains of around 11.5% over the next five years.
Final thoughts
Unless you believe that we do not need to increase the food supply, Monsanto Company (NYSE:MON) and Syngenta are must-have positions in the agricultural portion of any balanced portfolio. E I Du Pont De Nemours And Co (NYSE:DD) is a global brand and a fine business but is simply not valued attractively relative to Monsanto Company (NYSE:MON) and Syngenta.
Ken McGaha has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article 3 Businesses We Can’t Live Without and 2 You Should Own originally appeared on Fool.com.
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