A leading investment advisor warns that the risk in Monsanto’s business is higher than ever.

Monsanto: A food stock with a bad aftertaste

CHRIS UMIASTOWSKI
The Globe and Mail, July 29 2013
http://www.theglobeandmail.com/globe-investor/investment-ideas/strategy-lab/growth-investing/this-food-stock-has-a-bad-aftertaste/article13488677/

Chris Umiastowski is the growth investor for Globe Investor’s Strategy Lab.

As a growth investor with a long-term focus on stocks, it’s just as important to know what stocks to avoid as it is to know which ones to invest in. Most growth trends don’t last forever and you don’t want to be stuck holding the bag when growth disappears or reverses. And perhaps even better, if you’re willing to short sell stocks that you believe are negatively exposed to an industry change, you can add a margin of safety to your portfolio in the short term while potentially improving your long term returns.

Normally I write about traditional technology stocks and trends, but you may not realize that what we feed ourselves and our families has a lot of biotechnology baked into it. I’m a firm believer that the generally poor quality of the food we eat, as a population, is the root cause of the vast majority of illness. The food industry, like any other, is about scale and efficiency. But when it comes to food, the techniques used to produce it in higher quantities and at lower cost have plenty of people scared about a tradeoff in quality.

One of the major technologies used to grow crops, for example, is the genetic engineering of seeds. Corn and soy are by far the dominant crops grown using this technology and they are staple ingredients for meat production. These plants are fed to cows, pigs, and other animals that we regularly find in the butcher section of our grocery store. Cheap, genetically engineered corn and soy make for cheap meat.

In the U.S. and Canada, a huge amount of corn is also used to manufacture high-fructose corn syrup (HFCS), a cheap sweetener that has replaced ordinary sugar in almost every sweetened beverage on the market. In case you’re reading ingredient labels, HFCS is referred to as “glucose-fructose” in Canada.

Monsanto Co. is the industry giant when it comes to creating, patenting, and selling genetically modified (GM) seeds and associated chemicals such as the herbicide Roundup. Most of Monsanto’s sales are in the U.S. market, where there is no legal obligation to label GM ingredients as such. And this has played to Monsanto’s advantage. The company’s stock has performed ridiculously well over the last decade. It’s up about tenfold in 10 years. That’s the kind of gain people don’t complain about.

But there is a battle raging between consumers and Monsanto. I don’t have enough space in this article to dive into the science, but suffice to say that many industry experts believe genetically modified crops negatively affect our health. This is leading to a big push for better labelling, so consumers know if they are buying genetically modified foods or not.

In many European countries, such labelling is already standard practice. This is almost certainly the reason Coca-Cola, Pepsi, and other sweetened beverages are manufactured using regular sugar rather than high-fructose corn syrup. The soft drink companies would rather not have to label their product as genetically modified.

But I think we’re on the cusp of increased labelling requirements for GM ingredients. Whole Foods Market announced that its suppliers must label foods as containing GM ingredients within five years in the U.S. and Canada.

Robyn O’Brien is a food writer, author, and former food industry buy-side analyst whom The New York Times called “food’s Erin Brockovich.” In our recent conversation she pointed out that in just this calendar year there have been more than 90 pieces of proposed legislation to label GM ingredients in at least 26 different states across the United States. Most of this proposed legislation failed to make its way into law, but progress has been made in places such as Maine and Connecticut. Also, retailers such as Target, Safeway, and Chipotle are either labelling these ingredients or choosing to opt out of them.

Clearly the trend will be toward more ingredient labelling, not less. And this poses a big danger to Monsanto. Why? Because no major food company wants to slap a GM label on its packages. If you were the CEO of Coca-Cola or Pepsi or Nestlé, wouldn’t it make sense to avoid the risk of having to label your products as containing GM ingredients? And as soon as one major food company announces a plan to transition away from them, the rest will follow. High-fructose corn syrup use would dry up here in North America, and beverage makers would go back to using sugar, which is not genetically modified. Given the importance of GM corn to Monsanto this could spell big financial trouble.

Earlier this month, Monsanto said it would withdraw all pending approval requests to grow new types of genetically modified crops in the European Union. Based on reports, it seems strong public opposition to the technology isn’t expected to go away. Monsanto is a company with a $54-billion market cap whose stock trades at nearly 20 times next year’s predicted earnings. What happens when the U.S. starts to behave more like Europe? What happens when major food companies stop using GM ingredients in order to avoid having to label them as such? Wall Street cares about the next quarter, or perhaps even the next year or two. None of what I’m discussing will be relevant in that time frame. But I’m thinking 10 years out or more.

It seems to me the risk in Monsanto’s business is higher than ever. Their reliance on selling genetically modified seeds is quite high, especially with over half of sales happening in the U.S. market. Consumer awareness over potential health issues is on the rise, as evidenced by the company’s actions in Europe. If this consumer behaviour grows around the world, Monsanto’s growth suffers, as does the share price.

Personally, I’d rather own a business that is not only growing at a solid clip, but feels good to hold in my portfolio. For me, Monsanto doesn’t cut it. I’d be more inclined to short the stock at these levels, but only with a long-term view towards a decline. I have no reason to believe the next year or two will be anything other than financially strong.