Executive Summary
Market
Agricultural seeds is an attractive market with
secular growth driven by (i) increasing world population (ii) increasing meat
consumption / calorie intake and (iii) increasing usage of agriculture to
produce energy. Sales are recurring since crops need to be planted each year
and farmers overwhelmingly buy new seeds each year either because the quality
of hybrid seeds erodes over time, or because the law prevents them to (IP
protected seeds).
It is a concentrated market in the developed
world (top ten players represent 75%+ of the world market) which is highly
protected by (i) patents (genetically modified traits), (ii) know how (hybrid
seeds) and (iii) the international scale necessary in development, production
and distribution. There are ample consolidation opportunities in the developing
world (Asia, Latin America, Africa), where thousands of small companies are
still active.
The seeds market is significantly impacted by
regulation. For example, intellectual property rights are recognized and
enforced in developed markets, several countries have various forms of
production quotas and farm subsidies, and recent bio fuel regulation boosted
usage of farm products. Genetically Modified (“GM”) seeds is a lawsuit heavy
industry.
There is a major influence of weather on seed
production costs, and of commodity prices on yearly volumes. Seed prices are a
function of supply and demand and also of the nature of the traits present in
the seed. Seed costs as a percentage of total farming costs have significantly
increased over time to reach 10-15%.
KWS Saat
KWS Saat is a relatively small player in global
seeds (3.6% global market share) with 57% of sales in Europe, 38% in the US and
5% in the rest of the world. The company has historically strong position in
sugar beets (29% of sales), with an increasing importance of corn in total
revenues (61% of sales). The company is underrepresented in high growth
emerging market (notwithstanding a recent acquisition in Brazil). In addition,
its patent portfolio, particularly in GM seeds, appears weak compared to major
players such as Monsanto, Syngenta or Pionner Hi-Bred. KWS has introduced GM
sugar beet in the US in 2007 in partnership with Monsanto (applying Monsanto's
patented gene to sugar beets), and the first proprietary (through Genective,
the R&D JV with Vilmorin) commercial GM corn seed will reach the market in
2016.
KWS has enjoyed high growth in the past (9.4%
cagr over the last 12 years) while maintaining a very solid balance sheet (Net
Debt at €5 million taking into account the pension liability) and profitability
(Ebit margin at 13.1% and ROIC at 18.2%), demonstrating a solid business model.
The latest announcement forecasts a 5% revenue growth for FY 2014 and a decline
of Ebit margin to 11.5%, resulting in €139 M Ebit (down 8% from €150M in 2013).
Even if R&D has stayed constant as a % of sales, Ebit would have declined,
reflecting the increased relative importance of corn, where KWS has much lower
margins (probably due to higher license fees paid to Monsanto and higher marketing
costs). Given its product portfolio, KWS should grow organically by 5 to 7%
cagr over the next 5 years.
KWS in a portfolio
Owning KWS is a way to participate in the
agriculture market / participate in a resource scarcity paradigm shift (see GMO
Quarterly Newsletter April 2011 for a good explanation of this thesis).
However, value creation is dependent on sustained growth and profitability.
KWS is not a value stock, but a growth story
currently trading at a full price (11.7x E2014 Ebit, 20.2x 2014 P/E). A €3
dividend gives a dividend yield of 1.22%. Recent decline in agricultural
product prices will negatively impact sales and profitability in the coming FY.
The buy / sell decision is therefore highly dependent on the long term profitability
growth potential of the company. It is not a screaming buy at €260, but acquisition
below €250 provide with an interesting long term hold stock.
Potential upside
Increasing margins
·
Economies
of scale
·
Successful
patenting of GM seeds in 2016
Higher demand than OECD forecast
·
Chinese
imports
·
Biofuels
(ethanol, methane)
·
Emerging
market growth
Better performing seeds / market share gains
·
Corn
market share gains in the US (currently 6.5% market share, target 10% in 2018)
·
Corn
research JV with Vilmorin: proprietary GM corn trait in 2016 for the US market,
which would increase profitability (lower license fees paid, and fees inflow
from companies using the trait)
Acquisitions to gain new market access or new
technologies
·
India,
China, Africa
Partnership with a chemical company to offer a
One Stop Shop to farmers
·
One
stop shop offer: seeds, chemicals and a manual bundled in one offer to farmers
·
Integration
with chemical company: seed protection, crop protection
Regulatory environment
·
More
biofuel production (EU and US)
·
More
flexible GM adoption in EU
·
End
of EU sugar production quotas (2014/2015)?
More aggressive balance sheet yielding better
shareholder return
Risks
Family controlled, with limited third party
influence capability, very limited potential for a take-over (would already have
happened)
Lower growth leading to a de-rating and
multiple contraction
Increasing dependence on corn (Forecast 65% of
sale in 2014), increasing volatility and lowering profitability (corn Ebit at
13.1% compared to sugar beet at 22.4% and cereals at 24%)
Price pressure and decreasing planted area when
price of corn / sugar beet decline
No exposure the fastest growing product,
soybeans
KWS is weather dependent; the industry can have
a bad year, or two.
Lower return on R&D, although the impact
will not be felt for several years
Regulatory environment: antitrust
investigation, end of biofuel incentive regulation, higher hurdles for
commercialization, etc
Litigation: at the moment, KWS is not involved in
significant litigation, but GM crops tend to generated above average litigation
levels (e.g. GM contamination of conventional crops in Europe)
Currency impact of various currencies (USD,
Real, Argentina Peso, etc)
Further diligence I would like to conduct
Interview with management and industry
participants
Develop a detailed sales and cost model to
derive a better DCF valuation
R&D analysis
·
Patent
portfolio
·
Licensing
fees and payments (hypothesis: net outflow for KWS Saat, increasing with
increased corn sales)
Regulatory evolution:
·
Roundup
Ready 1 coming off patent in 2014
·
Biofuels
development in Europe and in the US
·
Potential
increased usage of GM crops in Europe
·
Lawsuit
potential due to GM crops (e.g. 2010 ban in the US on already planted sugar
beets)
Alternative investments to participate in the
agriculture trend
·
Other
seed providers: I would prefer Syngenta over Monsanto and Vilmorin, but DuPont
is an interesting stock to analyze, although the farm thesis is less direct.
·
Fertilizer
companies (Yara, Agrium, The Mosaic, PotashCorp, etc)
·
Crop Protection (Syngenta, Scotts)
·
Machinery
(e.g. John Deere at 9.5x P/E)
·
Farmland
(real asset play)
Business Analysis
Exhibit – Farm Seed Producers Business System
Pricing Power: good
·
Seeds
are mission critical for farmers, key element to yield and profitability
·
Premium
seeds represent 10 to 15% of total farming costs
·
Price
have historically increased faster than inflation
Industry Structure: Average
·
Somewhat
sticky relationship with farmers
·
Moderate
switching costs
·
Very
small customer concentration
·
Rivalry
with competitors but also cross licensing and partnerships
Barriers to entry: Very High
·
Very
high Intellectual Property (patents and know-how) and R&D expenses
·
High
regulation of novel seeds introduction
·
Large
infrastructure required to customize products to local conditions
Overall, KWS is a solid business with high
barriers to entry, good pricing power in a competitive industry.
Market drivers
The market benefits from several positive
secular trends:
Need to double food production by 2050
·
Increased
consumption of food products
o
Expanding
world population
o
Increased
consumption of meat, requiring more feedstock
·
Development
of alternative use for food products
o
Bio
energy
o
Bio
materials such as plastics and polymers
·
Arable
area is not expanding, maybe shrinking due to urbanization
Increase usage of feedstock to produce energy
·
30%
of US corn production used to produce ethanol
There is few if any new land to grow food
unless forests or the sea are used. Increased food production means increased
productivity per acre:
·
Irrigation
and mechanization
·
Fertilizer,
insecticides and herbicides
·
Higher
yield seeds
Irrigation and mechanization are costly,
require significant maintenance and more importantly, access to water which is
an increasingly strained resource.
Soil and plant treatment is already widely
used, and new product introduction requires increasingly high investments, so
better seeds are a clear path towards increased food production.
Seed technology
Various technologies are used develop better
seeds / traits :
·
Breeding:
artificial cross pollination is the conventional way to develop new varieties
(Hybrids). Contrary to naturally occurring open pollination, characteristics of
the plant are not stable requiring the acquisition of new seeds for each
harvest (no seed saving).
·
Biotech:
use of genomics and biotechnology to develop seeds with desired traits that are
not or extremely rarely occurring in nature (Genetically Modified). GM seeds
tend to keep their traits and can be saved for the next crop, a practice that
patent holders prohibit (IP laws and TRIPS agreement).
·
Mutagenesis:
Expose of seeds to mutagen factors (such as irradiation, intense UV light or
chemicals) to create non naturally occurring genetic variations. Resulting
seeds are not considered GM and therefore currently much less regulated.
In addition, different techniques enable a fast
identification of the impact of genes on actual field performance, including
genome maps of various crops, genetic marker technologies, cell and tissue
culture and massive DNA sequencing. For example, KWS identified with Bayer Crop
Science a very rare naturally occurring genetic variation and sampled 1.5
billion cells to find one with the said mutation.
Plant selection brings an increasing number of
desirable traits:
·
First
Generation Traits
o
Herbicide
Tolerant - HT (e.g. Glyphosate tolerance, or “Roundup Ready”)
o
Resistance
to insects
o
Resistance
to viruses
·
Second
Generation Traits : enhanced qualities
o
Better
nutriment content
o
Higher
sugar / oil / Protein content
o
Longer
shelf life
·
Third
Generation Traits: special substances production (pharmaceuticals)
Market – Size and development
The global seeds market is estimated at
approximately $45 billion in 2013[1] (8.9% growth 2011-2012), dominated
by Corn (40%), Soybean (18%), vegetables (15%) and Cereals (7%)1.
Another source gives a total of $37.5 billion in 2012 with GM seeds accounting
for $18.5 billion and growing at 18%[2].
In 2012, 170.3 million hectare of GM crops were
planted worldwide, out of 1 396 million ha arable land (12.1% of the total)[3]. Usage of GM seeds (versus
conventional seeds) is still very different by country (88% GM corn in the US,
very limited usage in Europe).
The global seed market has grown at 5.6% cagr
during the period 2005-2011. It has been observed in the recent past that the
demand for commercial seeds was primarily generated in the emerging markets of
Latin America such as Brazil, Eastern European countries, Asian countries such
as India, China, Korea and several others South East Asian countries.[4] The key success factor still remains associated
with the technological developments and the innovation of new and improved
seeds with specialized traits such as drought tolerant seeds.
There are conflicting reports on the GM growth
rates[5]. But two facts are certain: (i) GM
seeds are growing 2 to 3 times faster in developing economies compared to
developed ones and (ii) GM seeds are growing much faster than conventional
hybrid seeds. Both Transparency Market Research and Philip McDonnagal
Consultants estimate that GM seeds represent approximately 45% of the total
market in 2011.
Various consulting firms predict a 6 to 8% cagr
growth until 2018, led by LatAm, Asia, corn and soybean. Transparency Market
Research predicts a 6.5% cagr increase until 2018, with GM crops growing at 10%
while conventional crops stagnate[6]. These GM numbers broadly reconcile
with a 6% area growth and a 3% price increase yearly.
Exhibit - Domestic market seed value – 2012
(source International Seed Federation)
Volume
Simply put, market volume is the result of
planted acreage, adjusted for farm seed usage and plantation density. In 2006
farm seeds represented 21% of total market[7]. Farm
seed usage has significantly declined in the past decade and has almost
disappeared in developed countries, except for organic farming. Plantation
density tends to increase with better technology, but the main driver remains
planted area.
Impact of Price on
Volume
Commodity price has an impact on farmer’s
profitability and therefore total planted area, since there is an arbitrage
between types of crop depending on selling price.
·
The
boom in corn price in recent years can be partially explained by two difficult
production years in the US with lows yield and therefore lower total
production. However the recent decline in price will put pressure on the corn
acreage planted in 2014. The FAO forecasts worldwide growth for corn planted
area at 8% from 2013 to 2022[8].
·
USDA
lowered the projected 2013-14 season-average farm price for corn by 10 cents at
the midpoint and narrowed the range to $4.05 to $4.75 per bushel. “Rising
soybean prices and falling corn prices could pull more acres into soybeans this
spring” - Peter Georgantones executive
at Roy E. Abbott Futures, 10/12/2013[9].
·
There
is no sugar beet contract, but sugar prices have been declining since the 2011
peak. The FAO forecasts a decline in sugar beet production until 2020, mainly
because of the growth of sugar cane as an alternate source.
The following graphs detail the price evolution
of corn and sugar (proxy for sugar beets):
Planted Area Evolution
by Type of Seed
Soybeans and corn are the two types of crops
forecast to grow in area the fastest. Sugar beets however should decline
relatively fast (-5%), while sugar cane will grow at 13% cagr.
Exhibit – OECD Forecast on evolution of various crops (Corn = Coarse
Grains)
Part of the explanation for corn growth is
explained by the anticipated growth in bio fuel
Price of seeds
Price is mainly the result of traits
characteristics and of supply and demand. In 2012, prices have increased
significantly: +5-7% for corn and +10% for wheat, in part because the 2011
growing season was difficult in the US. Over the last 10 years, seed prices
have increased 7% cagr, significantly outpacing inflation[10]. Select
traits can also see their price fluctuate depending on demand (proliferation of
an insect type in a region for example). However, corn seed cost is
significant, representing approximately 10-15% of total farmer costs (including
labor, rent, machinery)[11].
Impact of Weather on
Seed Companies
There are several impacts of weather:
·
KWS
Saat production of seeds depends on weather for yield. Low yield will
necessitate contra cyclical production in the other hemisphere, resulting in
higher production and logistics costs.
·
Demand
for certain of seed: a record yield year will drive the price of the commodity
down, and acre sawn tend to decrease leading to lower seed sales. For example
in 2011, corn cultivation area surged in Northern Europe as a result of
extensive damage to winter cereals caused by frost.
·
Demand
for certain traits (drought resistance for example) is impacted by the previous
year weather conditions.
·
Bad
weather also has an adverse consequence on the quality of farm seeds, pushing
farmers to buy company seeds instead.
Overall, it is difficult to precisely evaluate
the consequence of weather on KWS, but it definitely has an impact and
introduces variances across the years.
Patents – Key Success Factor
It takes a decade and at least $150 million to
develop and commercialize a new genetic trait. Traits are protected by a 20
year patent, and the recent trend is to “stack” several traits (e.g. Roundup
Ready with both insect resistance and higher protein content would be “triple
stacking”). This involves multiple licensing agreements, with companies like
Monsanto receiving large net inflow of licensing fees from their extensive
patent portfolio.
Patents also prevent farmers to use part of
their crop to plant for the following year. Monsanto is an aggressive patent
enforcer with hundreds of farmers randomly tested in the US to ensure they pay
a licensing fee even if they did not buy seeds. Monsanto alone has initiated
more than 150 lawsuits against farmers (with many more settling out of court
before litigation). Bowman vs Monsanto was ruled by the Supreme Court in May
2013 at the benefit of Monsanto.
The first generation of Roundup Ready will become
the public domain in 2014. Monsanto has developed Roundup Ready 2 in 2000, but
competitors will have access to the “generic” form of Roundup Ready. Monsanto
sued DuPont Pioneer over the stacking of a licensed trait with other traits,
and won the appeal in August 2012. It is unclear if competitors will need
Monsanto’s approval to stack the generic Roundup Ready with their own traits
(Monsanto claims they will need approval / fees).
DuPont Pioneer will offer Genuity Roundup Ready
2 Yield and Genuity Roundup Ready 2 Xtend technology from Monsanto. This comes
at a minimum price tag of $1.75 billion, which DuPont Pioneer will make via a
series of royalty payments to Monsanto through 2023.
In many respects, the GM seeds market is
similar to the pharmaceutical industry at an earlier stage of development.
·
R&D
investments are significant and drive industry consolidation to maintain
critical mass
·
The
strength of the patent portfolio drives licensing revenues
·
Seed
companies are still very integrated (Research, Development, Trial and
Regulatory approval, Production, Sales and Marketing), whereas the
pharmaceutical industry has evolved into focused players in each of the value
chain segment
However, seeds company need to customize their
products to fit the natural and weather conditions of the area they are
focusing on: US Corn is not the best adapted to sell in India or Germany. This
explains why access to the market with development, production and sales
facilities is critical and therefore integrated.
Management
Management is conservative in projections and
forecast: on 31/12/2012 forecasts €140M Ebit for FY 2013, achieves €150M 6
months later. The balance sheet is also very conservative with no leverage,
enabling significant capital deployment.
Management is also acquisitive either to gain
access to new geographies (Brazil) or to technologies (JVs with Limagrain). The
CEO, Philip von dem Bussche is 63 years old, so there will be a management
transition in the next few years.
Governance – to be diligenced
Families control the supervisory board, but
don’t seem to be involved in management. This point would need to be diligence
further. This limits the potential for a take-over offer to surface.
KWS Competitive
Position
The seeds market is increasingly concentrated (see
concentration map at the end of the document) given the significant economies
of scale and the high R&D expense level required to produce innovation.
Given the significant barriers to entry it is an oligopoly with 5 or 6 players.
Absent of their particular shareholding structure (coops and families), KWS,
Vilmorin and Land 'O Lake would probably have merged with one of the 3 industry
leaders.
Acquisitions and technology are the biggest
drivers of market share increases. Monsanto and DuPont, in particular, have
acquired several independent brands in the past decade, which accounts for the
dramatic decrease in market share for local and regional companies. The subtle
changes in the past couple of years are primarily a result of aggressive
marketing campaigns, though new technology has also contributed.
Market Share
KWS has a good track record in increasing
market share, particularly in corn since it has already large market shares in
sugar beets (60% in the US for example).
Exhibit – Evolution of US market
share for Corn and Soybeans
One possible explanation is the fact that the
hybrid varieties on which it is introducing GM traits are well received by the
market and make a difference (GM traits are the same for everyone). KWS
germplast database has the required variety and quality.
The other source of competitive advantage for
KWS is its large production and distribution network. This allows the company
to customize its seeds for precise geographic conditions to maximize yield. It
also allows for rapid feedback from farmer and to establish a long term
relationship.
Overall, KWS seems to be gaining market share,
mainly at the expense of saved seeds and local/regional players. In the US,
DuPont Pioneer has also been quite successful, while Monsanto and Syngenta have
lost market share. These market share gains / losses would need to be better
understood with more due diligence.
R&D
The top 6 players have a combined market share
of 75% in R&D. Monsanto spends 50% of R&D on conventional breeding, the
other half on GMO.
An analysis of the US Patent Office database
since 1976 shows the dominance of Monsanto in seed patents:
·
Monsanto: 22850 patents, 82% of total
·
Pioneer
(DuPont): 3216 patents, 12% of total
·
Syngenta:
1721 patents, 6% of total
·
Vilmorin:
32 patents
·
KWS
Saat: 23 patents
The analysis of applications to the European
Patent Register confirms these numbers
·
Monsanto: 2616 patents
·
Syngenta:
2390 patents
·
Pioneer
(DuPont): 837 patents
·
KWS
Saat: 26 patents
·
Vilmorin:
13 patents
An analysis of patents applications on faqs.org
gives a slightly different view, with Monsanto behind Pioneer. KWS Saat has 7
applications (less than 1%).
Financial Performance
Top line growth has been excellent
historically, resulting from both organic and acquisitions / JVs. Over the last
12 years, KWS has grown 9.4% cagr. In addition to benefiting from the favorable
market dynamics, part of the growth comes from the successful US JV in corn,
which has become the largest crop for KWS in 2010 and is now representing 61%
of revenues. I estimate that KWS sells approximately 60% of conventional
hybrids and 40% of GM seeds, all of which using third party genetic traits
(license paying).
Ebit margin has recently declined from 14.3% to
13.1% due to high R&D and structure costs. Over the last 12 years, the Ebit
margin reached a low point of 9,2% in 2006 and high in 2012 of 14,3%. This is
better than peer and partner Vilmorin at 10.8%, but significantly behind the
industry leaders (Monsanto at 24%, Syngenta at 16.8%). Given the economies of
scale in the business, KWS has adequate margins compared to its larger
competitors.
The latest announcement for FY 2013/2014
forecasts a 5% revenue growth and a decline of Ebit margin to 11.5%, resulting
in €139 M Ebit (down 8% from €150M in 2012/2013). Even if R&D has stayed
constant as a % of sales, Ebit would have declined, reflecting the increased
relative importance of corn, where KWS has much lower margins (probably due to
license fees paid to Monsanto and higher marketing costs). However, with stable
segment margins as a hypothesis, the 11.5% overall margin seems low and implies
a significant increase in corporate costs (of which R&D). I estimate Group
Net Income at approximately €80 M (compared to €87M in 2013)
Valuation – KWS at €250
per share
KWS is a seasonal business, with very low sales
from June to December (approx. 20% of yearly sales) and sales can shift between
quarters, making quarter on quarter comparison somewhat difficult.
The peer group is Monsanto, Syngenta and
Vilmorin, the latter being the closest comparable since both companies have a
similar size, product portfolio and strategic position. The larger peer group
includes fertilizer and crop protection companies (Yara, K+S, Potash Corp,
Scotts Miracle-Grow, Compass Minerals, etc), as well as DuPont, the owner of
Pioneer Hi-Bred. The pharmaceutical industry is also interesting as it provides
insight into valuation once GM traits will go off patent.
I used KWS Saat own information and Capital IQ
for competitors (would need to do a more detailed analysis on competitors’
valuation metrics). The following table can give insight into relative
financial performance.
Growth is high at KWS, although the company
forecasts more moderate growth for the coming year. KWS does not publish
organic growth numbers but a detailed analysis could approximate this number.
In terms of profitability, KWS is more
profitable than Vilmorin, but significantly less than leaders Syngenta and
Monsanto. A detailed understanding of KWS Saat tax rate would help explain the
relatively low difference in Net Income margin with Vilmorin.
ROIC stands at 18.3%, which is very nice
(Monsanto at 28.5%). KWS is clearly creating significant shareholder value. I
have not calculated ROIC for all competitors, Monsanto stands at an amazing
28.5%, higher than Syngenta, indicating an attention by management to the
business asset intensity.
P/E penalizes companies with low or negative
net debt in the current very low interest rate environment. However, KWS tax
rate is higher than its peers at 35%, which needs to be reflected in the
valuation. In addition, all comparables have very conservative balance sheet
structures.
Over the last 5 year, KWS has outperformed its
peers, but has recently underperformed. Since 2009, Ebit is almost doubled,
explaining 2/3 of the stock price variation. There has also been a multiple
expansion since in 2009: the stock was trading at 8.3x Ebit and a P/E of 14.3. In
2009, KWS P/E as almost equal to the Eurostoxx 50 P/E, it is now trading at a
significant premium.
5 year
relative price chart – KWS, Monsanto, Syntegra and Vilmorin
10.8x Trailing Ebit is equivalent to 11.7x FY2014
Ebit using the company forecast, and it is a full valuation for a good quality
business with organic growth. Trailing P/E of 18.4x is in line with peer
Vilmorin (at 18.5x) and lower than Syngenta (20x) and Monsanto (24x), but 20.2x
2014 P/E is very full, particularly compared to peers with better strategic
position such as Syngenta and Monsanto (18.8x 2014 P/E). The pharmaceutical
industry has a forward P/E of approximately 14x. Over the last 5 years, KWS trailing
P/E has evolved in a 14x (2009) to 20x (2008) range.
Overall, KWS Saat appears fairly valued and
therefore not a “screaming buy” in the short term, however, the company has a lot
of potential in the medium to long term.
Conclusion
KWS is a very nice although relatively small
company participating in the attractive farming market. The business model is
solid with recurring and growing revenues, nice margins, good cash flow and
high barriers to entry, however (i) the R&D capabilities of the company
would need to be further investigated, particularly in GM seeds, (ii) corn
represents an increasingly large share of the business, which is increasing
potential earnings volatility and (iii) the relative small size forces
cooperation with other companies to remain competitive. Financial performance
is excellent with significant organic growth combined with sensible
acquisitions, although profitability is below that of industry leaders.
KWS is an exciting growth stock to own.
However, the current valuation level (€250 per share) combined with a somewhat
lower short term outlook prevents a massive buy. Recommend taking a small ticket
and reinforce when the stock retreats below €250.
