SANW - S&W Seed: Trying To Thread The Needle With A Refreshed Product Lineup And Growth Strategy

Summary

• After years of struggling to make progress with improved alfalfa varieties, the company has pivoted to Double Team, an herbicide-resistant sorghum variety, as its new growth driver.
• The arguments for herbicide-resistant sorghum are sound, as sorghum offers attractive economics and requires less water than corn, but has a broad use in animal feed, biofuels, and human consumption.
• Management continues on with its pilot stevia growing project with Ingredion; I see non-GMO stevia as a niche product and I'm not confident this will be a major driver.
• S&W has serious liquidity issues, including a going concern warning, and investors must approach these shares as a very speculative proposition.

It's been a while since I've written about S&W Seed Company ( SANW ) and the intervening period has not been particularly kind to this small ag-tech company. The company has continued to struggle to get farmers to use its higher-value improved alfalfa varieties and a distribution agreement with Corteva 's ( CTVA ) never really produced the hoped-for benefits; likewise with a venture into sunflower seed development. Management hasn't given up, though, and the company is hoping that new efforts in sorghum and stevia, in addition to better execution in the alfalfa and forage/cover crop businesses, can finally drive some momentum in the business.

This is an exceedingly risky proposition, and the company now has the dreaded "going concern" warning in its financial filings. It does seem that the new Double Team herbicide-resistant sorghum product is gaining some traction, but the company is pressed on liquidity and has only a narrow path forward, particularly as growing the sorghum business will require reinvestment. I can see meaningful upside from here if management can thread that needle, but readers should realize that this is an exceptionally speculative stock.

Can Double Team Do What Previous Product Launches Couldn't?

The S&W Seed story used to revolve primarily around the opportunity to market alfalfa seeds with enhanced traits like salt and drought resistance that carried higher ASPs. While S&W still has solid 15% to 20% share in the global alfalfa market, those enhanced seeds have never really caught on as hoped with farmers, and growth in this core business has disappointed.

Years ago the company diversified into sorghum and the company's subsequent R&D efforts have produced an interesting new product that could be the company's ticket to not just survival but more promising financials down the road.

The company has developed and launched Double Team sorghum, a non-GMO sorghum that is resistant to ACCase herbicides. Weeds can reduce sorghum yields by anywhere from 20% to 100% and at least some of the decline in sorghum planting in the U.S. (which has economics similar to corn and requires less water) from around 10M acres to 6M-7M over many years can be attributed to economic losses from inadequate weed control.

Double Team has been designed to work with FirstAct, an ACCase inhibitor-based herbicide sold by ChemChina 's ADAMA business. While Corteva and Alta have developed their own herbicide-tolerant sorghum varieties ( Inzen for Corteva), they are resistant to a ALS-inhibiting herbicides, and the issue there is that ALS-inhibiting herbicides have been widely-used for a while and some weeds have already evolved resistance to them.

S&W sold about $3M of Double Team in FY'22 and management believes they're on track for $12M in sales this year, at a 50% incremental EBITDA margin. If I understood management correctly, that works out to around 500K acres, or about 7% to 10% of expected U.S. sorghum acreage, which would suggest a very strong start. S&W is currently limited by seed availability, and this is going to be an issue for the company. They have to literally grow their product and that takes time and money, and S&W really doesn't have the resources to "over plant" in anticipation of strong demand.

I do see this as a promising product. As I said, the economics of sorghum are pretty favorable, and the grain has a range of uses. Most sorghum is used in animal feed, but it can also be used for biofuels and human consumption (including food, sweeteners, and the distilled hellfire-juice that is baiju ). Moreover, as sorghum requires less water than corn, it could be a more compelling alternative in areas where droughts are becoming chronically problematic.

Double Team isn't S&W only shot on goal for sorghum. The company has also developed a dhurrin-free variety that it hopes to launch relatively soon. Sorghum naturally produces dhurrin, and under certain circumstances that dhurrin can convert to prussic acid, a toxin to grazing livestock. Prussic acid poisoning is more likely during periods of drought, and I believe that a dhurrin-free sorghum variety could have appeal as a pasture crop.

Stevia Is More Sizzle Than Steak To Me

In addition to the base alfalfa/forage businesses and the sorghum opportunity, S&W continues to work on their stevia business. S&W has been developing stevia varieties for over a decade, and has managed to develop varieties that grow well in the U.S. (much of the world's natural stevia is grown in China) and can be mechanically harvested. This business got a significant boost in 2021 when the company announced a pilot production program with Ingredion ( INGR ) that will see the company grow stevia in the U.S. and then hand it over to Ingredion for processing.

There are a few reasons I'm not especially bullish on this endeavor. First, most stevia used in the U.S. is produced through yeast fermentation, and while bulls will talk about large dollar figures for the potential addressable stevia market, the real market that this project addresses is a much smaller subset - naturally-produced GMO-free stevia. Second, growing crops is generally a business with single-digit returns (often low-single-digit returns), and while S&W can use any profitable cash-generating product it can find, I don't see a particularly lucrative future in growing stevia for companies like Ingredion.

The Outlook

There are other parts of the S&W story that investors should investigate on their own, including a recent JV with Trigall Genetics that will help leverage the company's Australian wheat assets. In the main, though, this is a story tied to improved profitability in the core alfalfa/forage crop business and executing on the opportunity in modified sorghum, coupled with what I see as more speculative ventures like stevia and camelina (a potential crop for biofuel production).

I believe Double Team could take S&W to over $100M in revenue in FY'24 and possibly more than $120M in FY'25, and if things go well I could see the company breakeven on adjusted EBITDA late in FY'24 and generate positive free cash flow in around four years.

The question is whether or not the company can get there. Initial demand for Double Team seems strong, but the company will need to see further uptake and find the liquidity to expand production. Management recently increased its access to liquidity through expanded credit lines, but liquidity still remains an issue. At this point the company will need more cash to make it to cash flow breakeven, and I'm not sure they'll be able to do that on appealing terms.

It's not that unusual to see ag-tech stories trade for 3x forward revenue (and that has been a fairly common M&A multiple in the past). I think the serious liquidity challenges here argue for a discount, not to mention the company's past failures to execute on opportunities like enhanced-trait alfalfa, sunflowers, and so on. Still, at 2x forward revenue, the shares would trade for over $3 and that's a significant jump from today's price.

The Bottom Line

I'm not recommending that anybody buy S&W. Rather, this is a story that I've followed for years and I find the latest developments to be an interesting new opportunity for the company and one that could lead to better days (and better results).

At a minimum, readers need to appreciate that this is a highly speculative stock and one where management has to navigate the company through a pretty narrow window of liquidity/funding as it tries to support the growth of its promising Double Team product. Investors looking for a high-risk play in the ag-tech space, and one that does play on larger themes like increased drought risk, may want to investigate further, but this is definitely a cause where due diligence is a must.

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