This Market Leader’s Rebound is All but Guaranteed

As predictable as some market cycles are, they always seem to catch investors off guard. Mr. Market, senile old man that he is, just can’t seem to get past the euphoric buying around peaks and the panic selling around troughs.

Smart investors know they don’t have to time a bottom perfectly. Sector leaders will always bounce back, and the wisest investors know how to pocket cash while they wait for a rebound.

Some sectors are prone to extreme cycles. After a long period of high prices and capital investment, prices come crashing down and may take years to bottom.


The best example of this is in agricultural commodities like corn and soybeans. Over the past 100 years, corn prices have peaked five times with the most recent at $8.54 per bushel in 2012. Each time it happened, prices soon plummeted as farmers planted as many acres as possible and supply went through the roof.

Corn is now 55% off its 2012 highs, at $3.82 per bushel. Invariably, the drop in prices has led to a fall-off in planting and a drop in factors associated with increasing crop yields. And this, of course, takes a toll on companies in the agricultural space.

One best-of-breed ag company just announced tough job cuts and a restructuring program to protect cash flow. This company is No. 1 in most of its markets and is one of my favorite plays right now.

A Booming Global Population Will Need This Leader

There is virtually no doubt crop prices will rebound as market forces run headlong into growing global demand. Research published in the scientific journal PLOS One showed increases in crop yields are insufficient to meet the world’s demand for staple grains through 2050. In fact, the average yearly increase in the top four crop yields of 1.2% is half the growth needed to meet demand. 

If there ever was a company tied to the rising need for food, it’s Monsanto (NYSE: MON). The genetically modified seed supplier and chemical crop protection company holds the No. 1 market position in four of its five largest markets and is No. 2 in the fifth.

The company’s products help farmers produce more per square acre and protect their crops from damage. If the world expects to increase crop yields and feed a booming global population, it will need Monsanto to do it. 

Despite the slide in prices of agricultural commodities, shares of Monsanto continued to track higher until June of last year. That’s when lower crop prices really started cutting into spending and U.S. dollar strength hit the company’s foreign sales. Monsanto has booked declining year-over-year sales in three of the past five quarters.

In its most recent quarter, reported on Oct. 7, Monsanto posted a loss of $1.06 per share. Sales of $2.36 billion missed estimates by more than 10%. Management’s full-year earnings guidance of between $5.10 and $5.60 per share was also below analysts’ forecasts. 

But in this weak environment, Monsanto is positioning itself to protect cash flow. The company announced a restructuring that would cut its labor force by 12% and yield $275 million to $3 million in annual savings over the next two years. The company also said it will accelerate its share repurchase program, buying back $3 billion in shares over the next six months.


Earn a 33% Annual Yield While You Wait for the Inevitable Rebound

Shares of Monsanto are nearly 30% off their 52-week high and are trading for just 16.8 times the midpoint of management’s full-year earnings estimate. That represents a more than 30% discount to the five-year average multiple of 24.9.

Corn and soybean prices may not head higher right away, but Monsanto doesn’t need them to. The company generated $1.6 billion in free cash flow over the past four quarters without cutting capital spending. And it is on track to launch its next-generation Roundup Ready Xtend system in 2016, which it expects to be a strong growth driver. 

With MON trading at $89.70 per share at the time of this writing, we can buy 100 shares and simultaneously sell one MON Jan 95 Call, which is trading around $1.76 ($176 per contract). This gives us a cost basis of $87.94 per share, a 2% discount to the current price and just 8% above the 52-week low.

If MON closes above the $95 strike price at expiration on Jan. 15, our shares will be sold for that price. In this case, we will make $5.30 in capital gains, plus a quarterly dividend payment of $0.54. When you combine this with the option premium of $1.76 we received for selling the calls, we get a total return of $7.60, a profit of 8.6% over our cost basis of $87.94.

Since we’d earn that in 96 days, it works out to an annualized gain of 33% on a relatively safe, large-cap company.

That is a strong return to wait out the bottom of the cycle in agricultural prices. With global food demand rising and the need for crop yield drivers like the products sold by Monsanto, it’s not a matter of if the shares will rebound but when. Management has already made the tough decisions necessary to protect cash flow and prioritize shareholder return. All you have to do is collect your income and wait.

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