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While the current earnings season is shaping up to be a fairly good one for many sectors, few have as much to celebrate as the agricultural industry. Consider



: Thanks to a robust 27% increase in sales of its Roundup herbicide, two weeks ago Monsanto reported earnings per share of 88 cents for its fiscal third quarter, topping not only its initial guidance of 70 cents, but also surpassing even its most recent preannounced estimate of 85 cents.

It's no surprise then that Monsanto's shares now are heading back toward their 52-week high of $38. The stock already is up 7% since I

first highlighted it just one month ago, a far better performance than the 2% decline in the

S&P 500

in that same time frame. But Monsanto's shares could keep moving higher.

Biotech Growth Blossoms

Admittedly, counting on a good farm economy, which to some extent means betting on the weather, is rarely a good investment strategy. Fortunately, Monsanto's growth isn't entirely dependent on that. It is one of the world's leading developers and marketers of seeds and biotechnology traits related to control of weeds and insects and, more recently, weather resistance and nutrition, all of which help improve growers' productivity and profits. As such, Monsanto's business should thrive both in good farm economies and bad.

The fact is, Monsanto is becoming more of a biotech company -- and a very profitable one -- than an agricultural chemical company, which could only help the stock's valuation going forward. In that regard, the stock's current price-to-earnings ratio, even after this recent move, still looks reasonable. Street estimates already have moved higher in just the last month. For 2005, for example, the consensus now is looking for $1.92 per share, up from $1.86 previously. That might even prove to be on the low side; some analysts, like Merrill Lynch's Don Carson, already are using an estimate of $2.10 for next year.

Nevertheless, even using the lower consensus estimate means Monsanto's P/E has moved up to just 19 from 18.3. That's pricey compared with other chemical companies, but still reasonable compared with the P/E of 40 on the average biotech stock.

Growing Margins

Although Roundup may have performed better than expected in the third quarter, Monsanto's seed and genomics business continues to steal the show and will be the real driver behind management's realistic, if not conservative, goal of a 10% compound annual earnings per share growth rate over the next few years. Sales in seeds and genomics grew 11% in the third quarter, but more importantly, the gross margin was 60% for the third quarter in a row, compared with a high 30% range that the agricultural productivity business has been running at. Monsanto continues to benefit not only from the expanding size of the market for biotech traits, but also from the introduction of new products.

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Indeed, Monsanto now sees its total worldwide planted biotech acres reaching more than 170 million in 2004, up 14% from 2003. This includes growth from one of its more mature products: Roundup Ready soybeans, which are expected to reach close to 66 million acres this year in the U.S. alone, compared to just over 63 million acres in 2003. But it also includes growth in plantings that contain more than one biotech trait, also known as "stacking," which includes either weed control and insect control or double insect control traits in one crop. Stacked corn trait acres are expected to reach 9.4 million in the U.S. this year, up from 5.1 million last year. Biotech traits are estimated by some analysts to carry margins in the 80% range, so adding more traits to a crop can have a big impact on profitability.

Collecting Royalties

In addition to increased acreage of its biotech traits planted, Monsanto is getting higher royalty fees for the traits it sells. Monsanto recently announced that it was increasing trait fees on Roundup Ready soybeans from $11-$12 per acre to $15-$17 per acre and on Roundup Ready corn from $6-$8 per acre to $8-$10 per acre. Even if just part of this price increase sticks, it will probably add as much as 10 cents per share in additional earnings in 2005.

Furthermore, the company finally is having success at collecting royalty fees from grain handlers in Brazil, where growers had been purchasing Roundup Ready soybean seeds on the black market. This is an encouraging first step in a market that has very large potential for Monsanto and could add meaningfully to earnings in coming years. The company reportedly also is considering collecting royalty fees in Argentina as well, where roughly 90% of the soybean crop is Roundup Ready, compared with 30% in Brazil.

Near- and Long-Term Promise

The development of new traits, such as YieldGard Plus for corn, which was just approved for sale in Japan, also could provide good news for Monsanto's shares. Beyond enhanced weed and insect control, drought tolerance is the most promising new area. According to a recent report by Merrill Lynch analyst Don Carson, drought and heat account for three-quarters of the decline in yield on U.S. corn and soybean crops, so improved resistance to harsh weather conditions would have a potentially enormous appeal.

But while the company continues to focus on traits that will help the world's crop growers improve productivity, it is increasingly focusing its research and development efforts on what are called output traits, or those that will benefit the consumers of those crops: people and animals. For example, the company is developing corn and soybeans with higher levels of a certain amino acid that currently is added to animal feed as a supplement. In addition, the company is working on the development of soybeans that will contain omega-3 fatty acids, which are beneficial to the heart and could help reduce the risk of cardiovascular disease.

While the long-term picture for Monsanto looks promising, investors can be reassured in the near term by the company's strong financial condition. This should make its ongoing litigation exposure -- such as with

Delta and Pine Land


-- as well as its exposure to certain Solutia pension and health care liabilities much more tolerable. Indeed, on the second-quarter conference call, Monsanto CFO Terry Crews raised the company's expectations for free cash flow this year (before dividends) to $500 million from between $350 million and $400 million. Monsanto's balance sheet remains very healthy with a net debt-to-capital ratio of less than 20%.

While optimism in the farm belt may prove short-lived, investors in Monsanto could have a lot to look forward to for many quarters to come.

Odette Galli is a freelance columnist for She has been a writer at SmartMoney Magazine and a senior manager at Ark Asset Management, where she co-managed $3 billion in institutional assets. In addition, Galli was a senior vice president at J & W Seligman. At the time of publication, she had no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. She welcomes your feedback and invites you to send your comments to