Mega-Bets by All-Star Insiders Present Smack Down Challenge to Ugly Market; Who Was Buying?

By Michael Brush
Exclusively for InvestorIdeas.com
October 23, 2008

Insider buying continues to be exceptionally light – a troubling sign given that valuations look so cheap at so many companies.

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So when you see a couple of insiders with great records step up and plow big bucks into their stock it’s time to take notice, forget about all the negativity, and take a position along side them.

In short, now seems like a great time to get long Monsanto (MON), a technology company masquerading as a seed and herbicide producer.

While Monsanto sells the basics farmers use to grow their corn, soybean, cotton and other crops, its real edge is its ongoing research and development efforts that keep it ahead of the pack in terms of innovation and product quality.

Monsanto is also brimming with cash flow – an added plus when credit is so tight. 

Last week, one Monsanto director bought $5 million worth of stock, and another purchased $330,000 worth, at prices ranging from $76 to $93. On average, Monsanto stock has advanced anywhere from 40% to 60% after these two directors have bought stock.

The two directors were buying in the midst of a 45% pullback in their stock since June, to the upper $70 range. The stock has been weak for the following reasons.

• Farmers are looking at dramatic declines in the prices of corn, barley, sorghum, wheat and other agricultural products. Investors are worried that farmers will be so strapped for cash they’ll cut back spending on seeds and herbicides.
• There are fears that a global recession will reduce the rapid growth in demand for food products, particularly in emerging markets where a growing middle class was spending much of its newfound wealth on eats.
• Many hedge funds had big positions in the commodity play. Now that they are facing redemptions and they have to cut back on leverage as well, they are selling whatever they can. Quality names are getting hit hard – precisely because they are the ones where there is some buying interest, but not enough to provide decent support.

The bullish case

Take a step back and examine these “problems” from a position of calm, and they don’t really seem to justify the sell off.

First off, farmers have strong balance sheets because they were cautious about getting too wrapped up in the real estate boom. Instead, conservative farmers bought land with cash or used large down payments. Plus recent years of record grain prices have helped keep the balance sheets of farmers healthy, says Monsanto finance chief Terry Crews.

So the debt to asset ratio in the U.S. farm sector is below 10%, from a peak of 22% in the mid 1980s.

Besides, seeds and herbicides are the last things that farmers cut back on. First they’ll postpone the purchase of big-ticket items like farm equipment.

Next, while a global slowdown may cut into the growth in demand for grains, demand for food will still be there. And Monsanto is likely to stay ahead of the pack thanks to its ongoing intensive research and development that help it create new products to help farmers do a better job.

“Our fundamental belief is that if we focus on the things in our business that we control, and we do those things well, there's significant growth ahead for our business,” Monsanto chief Hugh Grant said in the company’s most recent conference call. “Greater grain demand drives the need for more yield. More yield requires more innovation, and the companies that innovate will grow. That's exactly who we are."

Monsanto is at its heart “a powerful R&D engine,” agrees Morningstar analyst Ben Johnson. On average, the company plows 10% of sales back into research, “but this figure belies the full scope of the firm's colossal R&D machine,” says Johnson. That’s because a lot of research-oriented companies team up with Monsanto, so that in return they can get access to its vast production capabilities and distribution reach.

The result is some phenomenal success stories.

Because Monsanto’s DeKalb corn seeds are so superior, for example, they have more than doubled their share of the North American market to 23% in 2007 from 10% in 2001.

Now, Monsanto is rolling out the next generation of its popular Roundup herbicide-resistant soybean seed. "Roundup 2 Yield" plus a new corn seed – among other advances -- should help produce significant growth ahead.

Strong cash flow

Meanwhile, Monsanto doesn’t have to worry about the mess in the capital markets when it maps out its research and development budget.

The company has a great return on invested capital north of 20%. That’s one reason net cash from operating activities was $2.8 billion in fiscal 2008, compared with $1.9 billion the year before. The company projects $1.8 billion in free cash flow for fiscal 2009. It has about $1.6 billion in cash and minimal debt. Besides research, the company is likely to use that cash to make acquisitions to expand internationally, and buy back stock.

Solid growth ahead

While many companies are slashing forecasts, Monsanto upped its 2012 gross profit projections to $9.5 billion to $9.75 billion from prior estimates of $8.6 billion to $9.1 billion, in early October. That would be an effective double in gross profits, from 2007.

The bottom line: Few market forecasters expect a “v-shaped” recovery in the economy or stock market from here. But food is a basic necessity, so one of the most innovative companies in the space is likely to provide decent returns. At least insiders think so.

Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site. For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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