When investing in equity in a high inflation environment, it’s of crucial importance to consider the impact of higher prices on a company’s business. The agricultural-input industry may offer some opportunities since the demand for its products and services is less elastic than in other sectors. I will explain why I select Corteva to be a top pick in a high-inflation environment and show that its stock is undervalued by 20.28% with a target price of $71.13.
A quick look at Corteva
Corteva Inc. (NYSE:CTVA) is a leading global agriscience company, which spun off from the chemical conglomerate DowDuPont in 2019. The company owns production and manufacturing facilities across the United States, sub-Saharan Africa, and Asia, employs over 21,000 employees, and offers a product portfolio of seed, crop protection and digital innovation in more than 140 countries worldwide. Its most significant business segment, Seed, grew 2.61% Compound Annual Growth Rate (CAGR) over the past 5 years, offering advanced germplasm and traits for a more efficient farming, with enhanced resistance to disease, weather, insects, and herbicides used to control weeds, as well as food and nutritional characteristics. It also includes digital solutions for assisting farmers in their decision-making, with a focus on optimizing the quality, efficiency, and profitability of their farming activity. During the same period, its second segment, Crop Protection, grew much faster with a 17.07% CAGR. This segment provides herbicides, insecticides, nitrogen stabilizers, and pasture and range management herbicides for protecting against weeds, insects, and other pests, and diseases, as well as enhancing crop health above and below ground through nitrogen management and seed-applied technologies.
The most important geographical areas in terms of revenue in 2021 were North America with 48.14%, the EMEA region with 19.95%, followed by Brazil with 14.79%, the Asia-Pacific region with 9.27%, and Latin America with 7.85%.
The company reported a consistently strong gross margin, averaging 41.25% in the past 6 years and reaching 41.10% at the end of 2021. Its operating margin growth reached 22.40% CAGR over the past 5 years and accelerated to 24.03% CAGR in the last 3 years, standing at 16.80% on December 31, 2021. Among some of its peers, the average gross margin was 35.18% and the operating margin was averaging at 24.19% in 2021, CF Industries Holdings (NYSE:CF) recorded the highest operating margin at 34.23%, followed by FMC Corporation (NYSE:FMC) with 22.86%, The Mosaic Company (NYSE:MOS) with 21.62%, and Nutrien Ltd. (NYSE:NTR) recording 18.04%.
Although Corteva has the lowest operational profitability among its peers, it significantly improved its capital allocation measured by the Return on Invested Capital (ROIC), up from an average of 3.81% over the past 3 years, and reported 9.04% at the end of 2021 Its peers are more efficient in their capital allocation, with CF Industries Holdings reporting 22.51% ROIC in 2021, FMC Corporation 17.65%, The Mosaic Company with 13.60%, followed by Nutrien with 10.86%. Corteva can still improve its already growing profitability, especially considering that it’s the only company among the analyzed peers, having a negative net debt position of $2.97B, and a leverage ratio of only 0.39, while the peers carry significant debt in their balance sheet, with a leverage ratio averaging at 1.60.
Corteva’s cash from operations significantly increased during the past years, up 32% Year-over-Year (YoY) to $2.73B, reporting significant growth at 41.37% CAGR in the past 3 years and ($275M) in 2017. The company also reported higher EPS at 29.50% CAGR over the last 5 years, up 149% YoY. Corteva has a very cyclical business with revenue and profitability typically accelerating towards Q2, while significantly dropping in Q3, which reflects the planting and growing season in the northern hemisphere; this gives the management a quite clear overview and leads to a more foreseeable and potentially efficient financial management.
Corteva in a high-inflation environment
In a high inflationary environment, it’s of primary importance for businesses to be able to protect their margins. This can most likely be achieved if the company has a strong price power, and can therefore increase its revenue by raising its prices, switching the sourcing strategy and reducing its input costs, or by quickly adjusting its strategy and prioritizing higher-margin products.
The agricultural-input industry is indeed inflation-hedged. Over the last 12 months, inflation in the US went from 4.2% in April 2021 to 8.5% in March 2022, and the iShares MSCI Global Agriculture Producers ETF (NYSEARCA:VEGI) greatly outperformed the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) , by returning 9.94%, while investing in the S&P500 index would have returned a loss of 1.92%. During the same period, Corteva’s stock outperformed both references by returning 16.40%.
As the demand for agricultural-related products and services is mostly non-discretionary, the sector performs well even during times of high inflation. This is especially true for companies in the agricultural-input industry with strong pricing power, licensed products, and long-term customer relationships as it’s the case for Corteva. As the CEO Chuck Magro stated in the latest Q4 earnings call
We’ve demonstrated that we can move prices to cover costs and grow margins
The company charges around 10% higher prices for seeds on a YoY basis, demonstrating a strong pricing power. The Green Markets North American Fertilizer Price Index has doubled in the past year and reached an All-Time High (ATH) at the end of March 2022, signaling the extent of the inflationary pressure on farmers and the global food industry, which seems to be persistent.
Although corn prices are expected to come down from their highs in the second half of 2022, they are forecasted to remain at a historically high level, offering a profitable environment for the company. The global agrochemicals market is expected to reach $336B by the end of 2026, expanding at 4.2% CAGR; Corteva has a strong moat, is investing significantly in Research and Development (R&D) with 7.58% of its net revenue in 2021, and is constantly expanding its global presence, recently with the opening of the first Center for Seed Applied Technologies (CSAT) in Europe, to take advantage of this highly profitable market environment.
To determine the actual fair value for Corteva’s share price, I rely on the following Discounted Cash Flow (DCF) model, which extends over a forecast period of 5 years with 3 different sets of assumptions ranging from a more conservative to a more optimistic scenario, based on the metrics determining the Weighted Average Cost of Capital (WACC) and the terminal value. Corteva reported consistent solid Free Cash Flow (FCF) growth, which is forecasted to increase at 13.17% CAGR over the coming 5 years, although I still consider a quite cautious forecast in my valuation model, especially in terms of a prudent perpetual growth rate, considering its significant impact on the DCF valuation.
The valuation takes into account a tighter monetary policy, which will undeniably be a reality in many economies worldwide in the coming years and lead to a higher weighted average cost of capital.
I consider the mid-valuation as the most likely scenario in my modeling, with a price per share at $72.15 or 21.99% higher. The low-valuation scenario, which I still consider to be very likely with rising interest rates, sees the share fairly priced at the current level, or at $60.04. The most optimistic scenario, which I consider to be the least likely in my modeling, prices the stock at $93.64 with 58.34% upside potential. I then compute my opinion in terms of likelihood for the three different scenarios, which gives a weighted average price target with a 20.28% upside potential at $71.13.
Corteva decided to withdraw from Russia by first pausing its sales and is planning to stop its production and business activities in the country. The company quantifies the business related to Russia and Ukraine at about 5% of its revenue, and since it’s mostly a Seed business, it will have a notable effect on the first half of the year. Despite the agrochemical industry being hugely dependent on gas supplies, Corteva is not directly exposed to Russian gas exports as instead its European peers BASF (OTCQX:BASFY), Bayer (OTCPK:BAYZF), or Syngenta AG. The company faces risks related to the ongoing consolidation and higher competitive pressure in the industry. Regulatory and perceived public acceptance of its products is also challenged, tighter regulations or founded claims concerning the safe use of its products could significantly affect its business. The high dependency on climate changes exposes the company to unpredictable changes in the demand for its products. Consistently lower corn prices could significantly reduce the ability of farmers to invest and drive down the demand for Corteva’s products or add pressure to its margins. Last but not least, further pandemic-related restrictions or extended disruptions in the relevant industries could delay some contracts or reduce Corteva’s capacities.
The stock reached its ATH at $62.04 on April 21, 2022, after a long uptrend since its All-Time-Low (ATL) at $20.38 on March 18, 2020. The stock had long periods in which it overperformed the iShares MSCI Global Agriculture Producers ETF (NYSEARCA:VEGI) and the S&P500, showing a significant relative strength since November 2021. From a technical analysis point of view, the stock has demonstrated to be resilient and is now consolidating close to its ATH, by testing the EMA50, which has served as trailing support since December 2021. Since it looks a little overextended in the short term, I don’t exclude a possible further consolidation in the coming weeks until the levels of the EMAs are more normalized and the stock has formed a solid base to continue its ascension. Alternatively, if the levels of the EMA50 are offering solid support, the recently marked ATH could be tested again.
Corteva can count on significant institutional support among its shareholders with 81.22% of the outstanding shares owned by institutions, and a low short interest of 0.80%. I estimate the stock to be a buy for long-term investors who want to invest in a high-quality business model and set up their long-term position in a high-inflation environment. Momentum, swing, and position traders could instead wait for the recent price-action to play out and observe if the recent levels will be kept and a possible base will be formed before entering a position, since the stock looks overextended, and could adjust after this high momentum of the last 6 months.
The bottom line
In a high inflation environment, investors want to look for companies that are less impacted by price increases and have more pricing power and capabilities of mitigating this risk in their business. The agricultural-input industry and especially agrochemical companies are less subject to margin crunches or a decrease in the demand for their essential products. Corteva has already demonstrated the ability to increase its prices and significantly outperform the market, with relative strength across its industry. The company has a very strong balance sheet and a cash-rich business and is anticipated to grow its profitability much faster than its sales in the coming 5 years, while continuously investing in R&D, as well as in its global presence. It’s a solid investment opportunity for long-term-oriented investors who are in search of a safer harbor during high-inflationary times, and the stock is fundamentally undervalued by 20%.