Corteva: A Top Pick for A High Inflation Environment (NYSE.CTVA).

Thesis on investment

It is crucial to consider the impact of higher prices when investing in equity in high inflation environments. There are some opportunities in the agricultural-input sector, as there is a high demand for its products.It is less flexible than other sectors. I will explain why Corteva is my top pick in high-inflation environments and show that its stock has a 20.28% undervalued with a price target $71.13.

Corteva – A quick view

Corteva Inc. (NYSE:CTVA) is a leading global agriscience company, which spun off from the chemical conglomerate DowDuPont in 2019. The company has production and manufacturing facilities in the United States, Asia, and sub-Saharan Africa. It employs more than 21,000 people and offers a product portfolio that includes seed, crop protection, and digital innovation in over 140 countries. Seed, the company’s largest business segment, saw a 2.61% compound annual growth rate (CAGR), over the past five years. It offers advanced germplasm and traits that allow for more efficient farming. These traits are resistant to disease, weather, insects and herbicides that control weeds. It also includes digital solutions that assist farmers in making their decisions. The focus is on optimizing their farming activity’s quality, efficiency, profitability. Crop Protection grew at a 17.07% CAGR during the same period. This segment supplies herbicides as well as insecticides, fertilizers, and range and pasture management herbicides to protect against weeds and other pests. They also help to improve crop health by using seed-applied technologies and nitrogen management.

The top three most important areas for revenue in 2021 were North America (48.14%), the EMEA Region (19.95%), Brazil (14.79%), and the Asia-Pacific region (9.27%). Latin America was 7.85%.

The company reported a consistent strong gross margin. It reached 41.25% CAGR over the past 6 year and 41.10% at 2021. The company’s operating profit growth has been 22.40% CAGR for the past five years. It has accelerated to 24.03%CAGR in the last three years, and stood at 16.80% on the 31st of December 2021. The average gross margin among its peers was 35.18%. The average operating margin was 24.19% in 2021. CF Industries Holdings was the highest at 34.23%. FMC Corporation was next at 22.86% with FMC Corporation at 22.86%, followed by FMC Corporation at 22.86%, The Mosaic Company at 21.62% and Nutrien Ltd. at 18.04%.

Despite having the lowest operational profitability of its peers, Corteva has significantly improved its capital allocation. Its Return on Invested Capacity (ROIC) rose from 3.81% to 9.04% over the past three years and was now at 9.04% at the close of 2021. Its peers are more efficient with capital allocation. CF Industries Holdings reported 22.51% ROIC for 2021, FMC Corporation 17.65% and The Mosaic Company 13.60% respectively. Nutrien had 10.86%. Corteva still has the potential to grow its profitability. This is despite having a negative net position of $2.97B and a leverage of 0.39. Peers have a greater amount of debt with an average leverage ratio at 1.60.

Corteva’s cash flow from operations has significantly increased over the past year, up 32% Yearover Year (YoY) at $2.73B. It also reported significant growth of 41.37% CAGR for the past three years and ($275M), in 2017. The company also reported higher earnings at 29.50% CAGR over 5 years, an increase of 149% YoY. Corteva is a highly cyclical company with revenue and profitability increasing towards Q2, and dropping significantly in Q3. This is due to the northern hemisphere’s growing season. This gives the management a clear overview that allows them to make more informed financial decisions.

Corteva in high-inflation environments

Businesses need to be able protect their margins in a high inflationary climate. This can be achieved if a company has a strong price position and can increase its revenues by switching its sourcing strategy and reducing input costs or by quickly adapting its strategy and prioritizing high-margin products.

Inflation is a problem in the agricultural-input sector. Inflation has been a problem for 12 months. InflationThe US went from 4.2% to 8.5% in April 2021, while the iShares MSCI Global Agriculture Producers eTF (NYSEARCA VEGI), returned 9.94%. Investing in the SPDR S&P 500 Trust eTF (NYSEARCA SPA:SPY) would have resulted in a loss of 1.92%. Cortevas stock also outperformed both references, returning 16.40%.

The sector’s performance is strong even in times of high inflation because the demand for agricultural-related services and products is largely non-discretionary. This is especially true of companies in the agricultural-input sector with strong pricing power, licensed product and a long-term customer relationship like Corteva. In the Q4 earnings call, Chuck Magro, CEO, stated that this was true for companies in the agricultural-input industry with strong pricing power, licensed products and long-term customer relationships.

We have shown that we can adjust prices to cover costs and increase margins.

The company charges 10% more for seeds YoY, which is a strong indicator of its pricing power. The Green Markets North American Fertilizer Price Index (ATH) has increased by 10% in the past year. This indicates the persistence of inflationary pressures on farmers and the global food sector.

While corn prices are expected lower than their highs in 2022’s second half, they are expected to remain at an historically high level which will provide a profitable environment for companies. The global agrochemicals market has been ExpectedTo reach $336B by 2026, growing at 4.2% CAGR. Corteva has a strong moat and is investing heavily in Research and Development (R&D), with 7.58% in 2021 of its net revenue, and expanding its global presence. RecentlyWith the opening of the CSAT (Center for Seed Applied Technologies) in Europe, we are able to capitalize on this highly profitable market.

Valuation

To determine Cortevas fair value, I use the following Discounted Cash flow (DCF), which covers a forecast period for 5 years and 3 sets of assumptions. These assumptions are based upon the metrics that determine the WACC (Weighted Average Cost Of Capital) and the terminal values. Corteva reported steady solid Free Cash Flow growth (FCF), which is expected to increase at 13.17% CAGR over 5 years. However, I still consider it a cautious forecast in my valuation model, especially considering its significant impact upon the DCF valuation.

The valuation takes into consideration a tighter monetary policy, which will undoubtedly become a reality in many economies around the globe in the next years. It will also lead to a higher capital cost.

The mid-valuation scenario is the most likely in my modelization. It has a share price of $72.15 or 21.99% more. The low-valuation scenario is still very likely, and I believe it to be extremely probable, with rising interest rate. However, the share is fairly priced at the actual level of $60.04. The stock is priced at $93.64 in the most optimistic scenario, which I consider the least likely based on my modelization. It has a 58.34% upside possibility. I then compute my opinion based on the likelihood of the three scenarios. This gives me a weighted average target price at $71.13 with 20.28% upside potential.

Risk discussion

Corteva DecentRussia to be withdrawn by first halting its sales. The company plans to cease production and business activities in Russia. The company QuantifiesIts business with Russia and Ukraine accounts for approximately 5% of its total revenue. This will have a significant effect on the first two-thirds of the year, as it is a Seed company. Despite the fact that the agrochemical and chemical industries are heavily dependent on gas supplies for their livelihood, Corteva isn’t directly exposed to Russian gas exports. Instead, it is exposed to its European peers BASF(OTCQX;BASFY), Bayer [OTCPK:BAYZF], or Syngenta AG. There are risks associated with the industry’s consolidation and the increased competition. The company’s regulatory and perceived acceptance of its products is also under threat. Tighter regulations, or well-founded claims about the safety of its products, could have a significant impact on its business. Due to its dependence on climate change, the company is vulnerable to unpredicted changes in demand for its products. Consistently low corn prices could negatively impact farmers’ ability to invest, drive down demand for Cortevas product or put pressure on its margins. Last but not least: additional pandemic-related restrictions, extended disruptions in relevant industries could delay some contracts and reduce Cortevas capabilities.

Market timing

After a long uptrend that began with its All Time-Low (ATL), at $20.38, March 18, 2020, the stock reached its ATH at $62.04 in April 2022. The stock has had long periods where it outperformed the iShares MSCI Global Agriculture Producers ETF(NYSEARCA.VEGI) and S&P500. This shows a significant relative strength from November 2021. Technical analysis has shown that the stock is resilient. The stock is now consolidating near its ATH by testing the EMA50. It has been trailing support since December 20,21. The stock looks a little stretched in the short term. I don’t think it is unlikely that there will be further consolidation until the EMA levels are more normalized. This would allow the stock to continue its ascent. The recently marked ATH could also be tested if the levels at the EMA50 offer solid support.

Corteva has 81.22% of outstanding shares owned or controlled by institutions. The short interest is 0.80%. This means that it can count on strong institutional support. The stock is a great buy for long-term, long-term investors who are looking to invest in high-quality business models and build their long-term positions in high-inflation environments. Swing, momentum and position traders should wait for the current price-action to play before entering a trade. This is because the stock looks overextended and could adjust following the high momentum of 6 months.

The bottom line

Investors are looking for companies that can reduce the impact of price increases and have the ability to mitigate this risk. Agrochemical companies and the agricultural-input sector are less vulnerable to margin crunches, or a decrease on demand for essential products. Corteva has proven its ability to raise prices and significantly outperform its market, despite being relatively strong in its industry. The company has a strong balance sheet and cash-rich business. It is expected to grow its profitability faster than its sales over the next 5 years while investing in R&D and expanding its global presence. The stock is fundamentally undervalued at 20%, making it a solid investment opportunity.