2023-11-11 20:33:00 ET
Summary
- Corteva is a leading global provider of seed and crop protection solutions in the agriculture industry.
- The company's growth has been driven by inflation and the Russia-Ukraine war, but a slowdown is expected due to dropping agriculture product prices.
- Corteva's seed and crop protection businesses have experienced remarkable growth, driven by inflation, global concerns about agriculture product supply, and investments in technology.
Corteva ( CTVA ) is a leading global provider of seed and crop protection solutions focused on the agriculture industry. The global seed and crop protection industry are dominated by a few players, including BASF (BASFY), Bayer (BAYZF), Corteva, KWS SAAT, and Syngenta. Corteva became an independent company after it spun off from DowDuPont in June 2019. After the spin-off, its growth has been accelerating in recent years driven by inflation and the Russia-Ukraine war. The global agriculture product prices have been dropping, and I expect Corteva’s growth to experience a slowdown in the coming years. I initiate with a “Hold” rating at the fair value of $40.
Seed and Crop Protection Business
The Seed and Crop Protection businesses account for almost 50/50 of group revenue and group operating profits. The two segments exhibit similar profitability margins. Corteva sells seeds for corn, soybean, and other oilseeds with a diversified geographic exposure globally. Its Crop Protection business provides herbicides, insecticides, nitrogen stabilizers, and pasture and range management herbicides. As illustrated in the table below, both businesses have experienced remarkable growth since FY20, with growth observed in both price and volume.
Their price and volume growth from FY20 to FY22 can be attributed to several factors. Firstly, inflation has played a role in their price growth, as Corteva possesses the global power to pass along the raw material inflation costs to its end-customers. These seed and crop protection products are essential for farmers, and customers generally have limited negotiation power with these manufacturers. In 2022, the Federal Trade Commission announced that they had filed a complaint in federal court against pesticide manufacturers Syngenta Crop Protection and Corteva, Inc. for allegedly paying distributors to block competitors from selling their cheaper generic products to farmers. However, given that these crop protection and seed products are controlled by a few global players, these manufacturers wield significant pricing power over their customers.
Secondly, the Russia-Ukraine war triggered global concerns about agriculture product supply. According to the USDA , Ukraine supplied 3.5% of global corn production, 30.6% of sunflower production, and 4.3% of wheat production. The war disrupted these crop supply chains, leading to a rise in agriculture product prices.
Lastly, Corteva has been investing in technologies to increase crop yield and production. These new hybrid and variety seeds carry a higher price point, contributing to their overall growth. In the Q3 FY23 earnings call , their management indicated that in 2024, they plan to roll out over 200 new hybrids and varieties worldwide, following the introduction of more than 300 in 2022 and 2023 combined.
Historical Financial Analysis
Since the spin-off, Corteva's revenue growth has accelerated, and its operating margin has increased from 2.6% in FY19 to 9% in FY22. Regarding their capital allocation, they deployed $2.25 billion of cash for share repurchases during the FY19-FY22 period and paid out $1.4 billion in dividends, out of the $3.9 billion of free cash flow generated during this period. In short, they utilized most of their free cash flow for dividends and share buybacks. Their balance sheet is underleveraged, with only a 0.5x gross debt leverage ratio, indicating a very robust balance sheet and capital allocation strategy. Additionally, Corteva is a capital-light business, with capital expenditure representing only 3.5% of total sales.
Cost Reduction Initiative
Corteva has been implementing a cost reduction initiative since last year, and they anticipate achieving over $300 million in cost savings in FY23 alone. As reported by Reuters , Corteva revealed plans to exit 35 countries and reduce its global workforce by about 5% as part of the company's cost-cutting measures in 2022. During the Q3 FY23 earnings call , their management outlined the next steps in optimizing their global crop protection network, including exiting production activities at their site in Pittsburgh, California, and ceasing production at other select locations.
This cost-cutting plan appears sensible, especially considering that when they were part of DowDuPont, there were numerous business layers and reporting lines. Their business had expanded into many unprofitable regions. Strategically, it makes sense for the management team to exit these markets and redirect capital to growth regions. Thanks to their cost reduction initiative and topline growth, their adjusted EPS grew by 24.2% in FY22.
Quarterly Review and Outlook
In Q3 FY23 , Corteva experienced a 13% organic revenue decline, with operating profits dropping to a loss of $161 million. The primary contributing factor was the significant collapse in volume, reflecting a 15% decline year-over-year. Specifically, their crop protection revenue saw a 20% year-over-year organic decline. The decline in Crop Protection volume was attributed to several factors, as explained by their management.
Firstly, product exits had a negative impact of $95 million, or 5%, on Crop Protection volumes. Secondly, there was inventory destocking in North America. Lastly, delayed farmer purchases in Brazil affected volume growth in this quarter. Given the pre-warning provided before the quarterly results, the market was not surprised on the earnings day.
I believe a key factor contributing to their sluggish growth is the declining price of crop products. As depicted in the chart below, the CBOT wheat future price has retreated to 2020 levels. The decreasing crop prices have implications for farmers' future income, potentially impacting their motivation to increase production in the coming years. This decline in price also represents a reversal of historical price trends. At the end of the day, crops are commodities, and when the supply exceeds demand, prices tend to decrease.
For the full-year guidance, the forecast indicates a 2% decline in revenue at the midpoint, with 3% headwinds from portfolio exits factored in. Operating EBITDA is expected to grow by 4% at the midpoint, while EPS is projected to decline by 3%. In comparison to their prior guidance, all forecasts have been revised downward, encompassing reductions across revenue, profits, and free cash flow.
During the earnings call , the management team also provided insights into FY24 and FY25 growth, anticipating a lower revenue growth rate in both fiscal years compared to the levels implied in their multiyear revenue target. In their guidance model, they expect tight Brazil farmer margins, influenced by high interest rates and low commodity prices, as mentioned earlier. It's noteworthy that Latin America accounts for over 25% of total revenue, making it a crucial market for Corteva.
According to USDA forecasts , wheat production in Brazil is estimated to decrease by 7% to 10.2 MMT next season, influenced by high production costs, lower expected farmer earnings, and prevailing weather conditions. In our opinion, it appears to be a down cycle for agricultural products at the moment. As global inflation begins to cool down, commodity prices are expected to return to pre-pandemic levels, and the additional growth driven by the pandemic and war is diminishing. This could exert significant growth pressure on Corteva.
Key Risks
Multiple Litigations : If you review their annual report, you'll find that their current litigations span multiple pages, which is quite understandable given their production of chemical products such as herbicides and insecticides. An example is the 2021 announcement by DuPont (DD), Chemours, and Corteva of a $4 billion cost-sharing agreement to settle lawsuits related to the historic use of the highly toxic "forever chemicals" known as PFAS, as reported in the media . In Corteva's FY22 annual report , it is disclosed that, under the terms of the memorandum of understanding ((MOU)), Corteva's estimated aggregate share of the potential $2 billion penalty is approximately $600 million.
High Inventory : In FY22, Corteva added $1.7 billion to their inventory, significantly impacting their working capital. The underlying logic is straightforward: they experienced robust growth in both volume and price during FY22, with a 15% organic revenue growth. During the earnings call, their management noted elevated channel inventories in Brazil, and the weak demand has posed challenges for inventory destocking at Corteva. The high inventory levels are creating difficulties for their working capital management and impacting free cash flow generation.
Foreign Exchange in Emerging Countries : Given Corteva's significant business presence in emerging markets, especially in Latin America where currency depreciation is a common occurrence, foreign exchange has had an adverse impact on their revenue growth. In FY19, the impact was a 3% reduction, followed by a 5% reduction in FY20, and another 3% reduction in FY22. The fluctuation in currency values in these regions has posed challenges for Corteva's financial performance.
Valuation
In the model, I forecast the revenue to decline by 2% and profit to decline by 6.4% this year, aligning with the management's guidance. The company is utilizing its cash for share repurchases, and I expect shares outstanding to decline by 1.5% year over year, consistent with their historical trend.
For FY24 and FY25, the revenue growth rate is forecasted to be at low-single digits, influenced by weak growth in Brazil and a decline in crop production prices. For normalized revenue growth, the model assumes 6% growth, comprising 3% price growth and 3% volume growth. Given Corteva's ability to pass along raw material cost inflation to their end-customers, a 3% pricing and mix growth seems reasonable. The forecasted 3% for normalized volume growth aligns with the long-term historical trend.
Due to their cost-cutting initiatives and new product launches, I am forecasting their operating margin to expand by 30-40 basis points per year, aiming for a 12.2% operating margin by FY32.
The model employs a 10% discount rate, a 4% terminal growth rate, and a 21% tax rate. The fair value of their stock price is estimated to be $40 per share.
Takeaways
I appreciate Corteva’s initiatives to cut costs and exit unprofitable markets. These endeavors could drive their margin expansion going forward. However, the weak demand in Brazil and global inventory destocking would exert tremendous pressure on their revenue growth in the coming years. Consequently, I am initiating a 'Hold' rating at the fair value of $40 per share.
For further details see:
Corteva: Weak Brazil Market, Inventory Destocking Challenges; Cost-Cutting Improves Margins