FMC - 3 Reasons To Buy FMC

2024-01-15 23:26:41 ET

Summary

• FMC Corp.'s stock has lost over half its value in the past year and appears to be out of favor, but we see three broad reasons to be optimistic.
• FMC is set to deliver 8% EBITDA and 21% EPS growth this year but is priced at a significant discount to its historical averages on the EV/EBITDA and P/E front.
• The cash conversion cycle is at unsustainably high threshold, and normalization here should take the FCF conversion over 100%.
• The charts look overextended to the downside, and we could see some mean-reversion.

Introduction

The stock of the agri science specialist FMC Corp. ( FMC ) has encountered a disastrous 12 months, losing over half its value, even as its peers from the material space have remained steady, and the broader markets have generated returns of 21%.

The significant erosion of wealth may have scared quite a few investors, leaving them hesitant to consider this stock, but once Q1 is out of the way, FMC would be in a good spot to reclaim lost ground. Nonetheless here are three broad reasons why we are optimistic about FMC.

Forward Valuations Don’t Capture The Likely Improvements At The Operating Line and Below

Given the drastic contraction in the market cap, it wouldn’t be a great surprise to discover that the FMC stock is now available at dirt-cheap levels; for context, on an EV/EBITDA basis, the FMC stock can now be owned at an EV/EBITDA multiple of a little over 10x, which translates to a 24% discount to its 5-year rolling average.

Given these dynamics, one could be forgiven for expecting a dismal EBITDA picture in FY24, but even if the market doesn’t witness significant growth, FMC is setting the foundation to generate healthy adjusted EBITDA growth of 8% next year.

Towards the end of last quarter, management already put in place some initiatives to readjust the resources of various functions (including the sales function) comprising the Brazilian business. Similar cuts were also seen on third-party costs and those linked to consultants and contractors, something which is expected to carry on in Q1 this year as well.

Management also plans to realign the costs across every business line and function across the group level in Q1, and the end goal is to engender around $50-$75m of cost benefits this year (with a similar cost-cutting run rate in FY25 as well). All in all, EBITDA margins, which stood at 21.6% as of 9M-23 could likely end up hitting 23.1% at the upper end of management’s guidance.

What’s also key is that the improvement at the earnings line is expected to be even more pronounced than growth at the EBITDA line. As per consensus expectations for FY24, we’re staring at pretty hefty earnings growth of 21% YoY.

Given such strong earnings growth on offer, it feels odd to see the business priced at only 13.3x forward earnings, as that translates to a healthy Price-to-earnings growth ratio of 1.63x. Crucially the current forward P/E also represents a sizeable 30% discount to its long-term average.

Better Working Capital Dynamics To Reflect Well on Cash-Generation

Underlying market conditions may not necessarily be tip-top, but in addition to the likely improvements that management will facilitate on the cost base, FMC’s working capital position too is expected to tilt quite significantly from what’s been seen off late. This could serve as a massive silver lining as it will catapult the FCF conversion quite significantly.

After peaking at the 80% levels in FY21, FMC’s FCF conversion has been trending lower; in FY22 it dropped to 55%, and FY23’s negative FCF of -$750m at the mid-point means the rolling FCF conversion average could drop to a lowly 21%.

As FMC recalibrates its production positioning, expect some of the excess funds tied with its inventories, payables, and receivables to ease off. To get a sense of the potential scope of improvement one may look at the current cash conversion cycle which is a good 60% above what FMC normally maintains (257 days). That figure is just not sustainable.

Management has also noted that transformation spend will be curtailed, and CAPEX will largely be critical projects linked to maintenance. All in all, cash conversion in FY24 will likely exceed 100% .

With an improved cash-generating position by the end of FY24, FMC will be well-positioned to bring down its net debt to EBITDA level down to 2x (on a rolling 4-quarter basis) from current levels of 3.8x . One wildcard here could also be the cash proceeds it receives from its global specialty unit, which consists of non-crop-related assets that have been put up for sale.

Closing Thoughts- Favorable Positioning On The Charts

After growing at a stellar pace of low double-digit growth last year (for context, over the last 40 years this market has grown at 3% CAGR), it was always going to be difficult to expect the crop protection market to trump the heydays of 2022, but record levels of channel destocking in the industry in 2023 have tilted things even further, so much so that the drop off has a few parallels with what was seen back in 2015 (orange highlighted bars in the image below).

Back then, the pressure was mainly felt in the Latam markets, with not just an excess build-up of channel inventory, but also the influx of new genetically modified crops which ended up crushing demand for insecticides in particular, which accounts for 58% of FMC’s topline.

In 2015 it took a couple of years of flattish conditions before the market began growing, but this time round, the FMC management has suggested that the market will start growing at 3% by H2-24 itself. There are some suggestions that growth may come in earlier than expected as the expected cut in policy rates could boost the viability of farms across the nation. In Nov last year, we already saw the USDA lift its inflation-adjusted net farm income forecasts by $10m (from what was provided in August), and given the expected pivot with interest rates, FY24’s net farm income numbers could be a lot more palatable.

All in all, we can get a better sense of the overall situation by also looking at FMC’s own long-term charts from 2015 onwards. From the bottom of 2015-2016, until May 2023, we’ve seen the FMC stock trend up in the shape of an ascending channel, with the RSI hitting or touching the overbought market across multiple instances.

Now after the stock broke down from the channel boundary, we saw strong selling until October, even as the RSI dropped to its lowest level since the 2015 slump. Since then, over the last couple of months, we’ve seen sentiment tilt marginally, with the stock showing signs of flattening out (like we saw in 2015), even as the RSI pulls back.

Notice also that the gap between the current close and the 20-period moving average also feels quite overextended and we could see this gap narrow in the months ahead, as the stock moves away from the lower Bollinger band.

In addition to that, we also feel that those investors who are looking for suitable bargain opportunities within the global agricultural universe could likely queue up to add FMC at these levels. We say this because the chart which measures the relative strength ((RS)) of FMC versus the MSCI Global Agri Producers Index recently dropped to levels last seen in 2015 and bounced from there. Interestingly enough, it also looks like the smart money was involved in driving that bounce, as is exemplified by the pickup in the net shares owned by them after months of relentless selling.

Crucially, note also how the current RS ratio is well over 40% away from the mid-point of its long-term range and may benefit from some mean reversion.

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