2023-08-23 05:33:21 ET
Summary
- The decline in FMC revenue is not due to a collapse in demand but rather a “resetting” of grower inventory.
- FMC has been steadily growing its EPS for the past 10 years and has an industry-leading ROE.
- FMC offers a decent dividend yield of 2.57%, and it has grown its dividends by approximately 7.7% annually.
FMC Corporation's ( FMC ) stock has sold down heavily since March this year. From a 2023 high of $133 to its current price of $88. This represents a drop of approximately 34% which is unusual for a low-beta stock. For reference, FMC stock's 24-month beta is 0.74 which typically indicates a more stable stock.
Such a drop can be undoubtedly awful for existing shareholders, but it does present quite an opportunity. Is it worth it to buy FMC shares after this drop? I believe so, as FMC is a solid business that has been viable long-term. It just so happened to hit a snag at the top of a potential business cycle. After all the Agricultural Chemicals industry can be cyclical. Here's why I think FMC is a stock to consider long-term.
Revenue Decline is Nothing More than Mean Reversion
The decline of FMC stock started in May when the company missed revenue expectations. It further accelerated this decline around July when it slashed revenue expectations. Full-year revenue outlook was revised to $5.2 billion to $5.4 billion compared to the previous expectation of $6.08 to $6.22 billion. Analysts currently have a consensus estimate of $5.27 billion based on 18 analysts' expectations.
FMC management cited an "abrupt and significant reduction in inventory by channel partners" in all four regions. The company was caught off guard by the rapid contraction in revenue. However, examining all the factors this outcome isn't too surprising. First of all, 2022 was an absolute banner year for the FMC Corporation. The company's revenue for 2022 was $5.8 billion a massive 16% jump from the $5.0 billion a year earlier. This year-on-year growth was much higher than the average 5.7% growth rate from 2018 onward. If you normalize the growth rates, the revised forecast of $5.27 billion is a lot closer to the trend than the $6.22 billion initial forecast.
In my view, I believe what happened was the uncertainty caused by the War on Ukraine and lingering supply chain issues from the pandemic caused end users to stock massive inventories of the company's product. Current macroeconomic conditions have made it more favorable to destock inventory. FMC highlighted three reasons on its earnings call:
- Increase in inventory carrying cost due to higher interest rates (thus favoring just-in-time usage vs maintaining inventory)
- A normalization of Supply-chains thus increased confidence of product supply (thus allowing for just-in-time inventory management)
- The drop in fertilizer and nonselective herbicides prices has led customers to be more cautious
However, one important piece of information that FMC management shared in the conference call was that on-the-ground consumption by growers remains at similar levels to last year. This would imply that the decline in revenue we are seeing is not due to a collapse in demand but rather a "resetting" of inventory levels. It is in my opinion once the de-stocking of currently held inventory is completed, revenue and revenue growth should normalize back to long-term trends.
Note: A major risk to this thesis is that a worldwide recession would decrease food consumption thus less need for Agricultural chemicals. However, I am not willing to bet on this as food is an essential purchase.
FMC is a Solid Long-term Investment
I am using the assumption that the decline in revenue is a special circumstance and not the start of a decline. So why exactly is FMC a good long-term pick?
FMC has been steadily growing its EPS for the past 10 years. The company's 10-year EPS CAGR is 7.18% while its more recent 5-year EPS CAGR is around 7.36%. In fact, its EPS CAGR is a bit faster than its 5-year revenue CAGR of 6.25%. This is largely due to efficiencies as well as stock buybacks.
FMC Corporation's Return on Equity is also much higher than its Chemical Industry peers at 18.8%. This shows how efficiently FMC is generating profits and funding growth internally. Because of this, I believe FMC deserves to trade at a premium over its peers.
FMC has a decent dividend track record as well. The company's dividend yield is also near its high at 2.57%. Admittedly, this dividend yield isn't too impressive when thinking given the high interest rate environment we are currently in. However, the company's dividends are growing at a healthy rate and are relatively safe.
Since 2018 (post-acquisition) the company has grown its dividends by around 7.7% per annum. The company currently has a payout ratio of 38.7% and a score of B+ for dividend safety in Seeking Alpha's quant rankings .
The company has about $4.2 billion in long-term debt since the latest quarter. Divide that by equity of $3.4 billion gives it a debt-to-equity ratio of 1.23x. Which entails that the company is in good financial shape.
Conclusion
FMC is currently trading at 14x forward earnings which is a pretty good valuation. As mentioned above the current challenges that FMC is facing are just a normal part of the business cycle. Over the long term, I believe revenue growth will return to the historical trend of around 5% to 6%. This is especially true as the company continues to put out new crop protection products. A reversion back to long-term trends should provide good upside for investors willing to take a risk at these levels.
For further details see:
FMC Corporation: Temporary Depressed Revenue Is A Buying Opportunity