Analyst Corner - Genetically modified crop fears take toll on agriculture stocks
European anxiety makes trade tricky
By Kristen Gerencher, CBS MarketWatch
Last Update: 6:51 AM ET Jul 6, 1999
NEW YORK (CBS.MW) -- It seems food scares have become almost
commonplace, from last week's Coca-Cola panic to the Odwalla juice
infections and even mad cow disease from several years ago.
So it should come as no surprise that consumers want companies to
disclose how they produce the food we eat. The debate has grown, and
now breaks down along international fault lines, with Europe publicly
questioning the safety of genetically modified food. Meanwhile,
shareholders are holding their breath, according to agriculture, chemical,
and fertilizer analyst James Wilbur at Salomon Smith Barney in New
York.
Wilbur talked with Kristen Gerencher of CBS MarketWatch about
why he remains bullish on the sector and whether we indeed are what we
eat.
What's the latest news from abroad? How's that affecting
the stocks?
The latest news has to do with genetically modified
foods. We have a situation here where Europeans
got concerned about what's in their food channel.
There's been more interest in fresh produce as well
as fresh juices, and so there's not as much
processing in between... A lot of the efforts to
modify seed that reduce the need for pesticides etc.
has been called into question by Europeans who
don't want genetically modified food.
How much of the business is based on
Europeans? How much will that impact what
goes in the States?
As most people know, the U.S. is not exactly the bread basket to the
world, but we do export a lot of product to the rest of the world,
particularly soybeans. We manufacture or grow a lot in the U.S. and they
purchase it in Europe. The problem here is one of making it here and
exporting it to countries that are senstive to what's in the foods.
The Europeans make
a lot of their own
wheat and grow some
of their own corn, but
soy beans is a more
sensitive item. So
while there is a
sensitivity on
genetically modified
foods, we have a
channel of distribution, which includes people like ... Archer Daniels
Midland (ADM: news, msgs) who have not been asked in the past to
identify what's in the food channel. And now basically consumers are
saying "we want to know" and that's going to create challenge all the way
from the farm on through to the stores.
What percentage of the food is exported from the U.S.?
Roughly about 12 percent of foodstuffs are exported, but in terms of the
European need for soybeans, it's up over 50 or 60 percent. That's (why)
it's a much more important issue for them for that particular commodity.
How are American companies responding? Have we seen
it hit the bottom line yet?
Yes it has. Monsanto (MTC: news, msgs) has seen
a reduction in their share price ... reflecting these
concerns. The reason being simply that
expectations for earnings growth included
continued sale of genetically modified seeds,
whether it's corn or soybean, into the American
farm environment.
With these issues being raised internationally,
especially in Europe, it has moderated the
expectation for earnings growth until the channel is
able to provide a segmentation and identification of
the products that are being made. We've seen that
Monsanto's share price currently has discounted
these issues.
Monsanto of course is very involved with drugs for
their products Celebrex and with their nutrition
products like NutraSweet. But the current valuation
gives very little credence to the seed and
biotechnology efforts that the company's made. The
market's done a very thorough job of discounting it in the stock price.
What's your top pick right now?
Well, our top picks are DuPont (DD: news, msgs) and Monsanto. Both of
these companies are seeking to get bigger growth in their biological areas
rather than the chemical areas. Part of it is because there's better growth
opportunities. Part of it is they have the opportunity to use their science in
both drugs and in agriculture. We feel that once they get these other
problems sorted out there'll be a terrific change in the valuation as well as
the earnings growth potentials for both companies.
What are your hesitations on the stock right now? What
are the risk factors?
The other thing is, we do have an excess of crops. We have an
expectation of probably the third best year of production of corn and
soybeans in the United States. As the prices of those commodities come
down and farmers are less inclined to pay full price for their seeds or their
ag/biotechnology.
So there has been pressure on these companies' products as the farmers
have sought to find other ways to use less product or generic alternatives.
If that would continue for another year, that would put pressure on the
earnings of both companies.
Is there any legislation from the World Trade Organization
or something specific to farmers that would change the situation?
The WTO issue affects probably more the fertilizers than the
biotechnology companies. Basically, China had shut off all the imports for
urea back in August of 1997. That was almost 2 million tons of urea that
were coming into China. They raised the trade barriers to a level there that
prices urea at two times the world price.
So if we were to work out something with China in these fall negotiations
in November, there would be huge opportunity for various fertilizer
companies (to go) into China and really help out demand dramatically.
We sort of see the
sectors being broken
into the value-oriented
stocks, which are the
Agriums (AGU: news,
msgs), the Potashes
(POT: news, msgs)
and the IMC Globals
(IGL: news, msgs),
which are the fertilizer
names, and then the more growth-oriented stocks like Monsanto and
DuPont. That value sector of fertilizers would be dramatically affected by
world trade.
Going back to your quesiton on legislation on the other side, I think
Europe has a fairly broken up set of rules dealing with foods and the
regulation of food stuffs. To the extent that they could get their legislation
to work out on a European Union basis rather than country by country,
that would help speed up the introduction and acceptance of genetically
modified foods in that part of the world.
How much does diplomacy play a role here?
I know that people have contacted Clinton to put
some of these ... ag-biotechnology issues on the
agenda for various talks they've been having at the
G-7, G-8 level. So I think diplomacy is critical
because there is a different view in the U.S. and
Europe about the safety of these products. The
U.S. is much more open-minded and accepting of
these things because we have more confidence in
our USDA and our FDA than the Europeans do.
To the extent that diplomacy would move us more
to a U.S. model, that would help the industry.
Because both DuPont and Monsanto have shown
some weakness on this issue of food safety and so forth there's a great
deal of upside potential for these companies as the issue is settled out.
Because what we believe is that with limited acres of land and with more
and more people, the use of biotechnology in agriculture is mandatory to
meet the food needs of the world. You're really trading off a short term
issue ... versus the long term demand. We think the long term demands
will win out...
In the long term, are you bullish on the sector?
Oh, absolutely. We're very bullish on the sector because we think that in
essence what the chemical companies are doing is displacing a lot of
insecticides and herbicides which aren't very environmentally friendly....
To the extent that you can use technology to get the plants to do their own
dirty work, so to speak, to get the corn plants to help kill the corn bores
that eat away at the corn stalk rather than spraying them with something,
we think that's a very strong environmental incentive to go that way. The
opportunities have not been tapped at all in rice and wheat, just mainly in
corn and soybeans, and so the potential is really huge.
Do you think more awareness from consumers has helped
to prompt that?
I think the awareness from consumers has raised the fact that the chemical
industry particularly has not taken into account consumers' desire to know
what's in their food and felt that as long as they, the chemical companies,
thought it was safe that people should be happy about that.
I think right now we're in a good period of debate where consumers have
said to the chemical industry, "Look, we're happy to accept these
changes. It'll bring down the cost of food or improve the quality of the
foodstuffs that are made, but you have to give us the option too, to pick it
if we want it." It's a bit of a variation on organic farming as another variant
of the same theme.
What are your picks on the fertilizer side?
My principal pick would be IMC Global, (which is) one of the largest
fertilizer companies. It would be a huge beneficiary of the opening of
world trade in fertilizer area. And secondarilly, they have an important
cost-reduction program going on right now that will raise 60 million over
the next couple of years. We also see the cash flow is running at about 4.5
to 5 bucks per share which is a very attractive level given that its share
price currently is about $19.
Any closing thoughts?
The market tends to have emotional swings. The current negative
emotional swing on genetically modified foods has created some great
value opportunities in the ag-biotech sector with Monsanto and DuPont.
On the other side, there's opportunity in fertilizers with world trade that
should keep people very aware of two very interesting subsectors in the
life science and chemical industry.
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