Dow Chemical's Liveris Interview: Part III- Agriculture

In part three we discuss Dow Ag and the agricultural sector in general including DuPont (DD) and Monsanto (MON).

Todd:
Roughly a third of earnings in the most recent quarter were Dow Ag. After you sell the commodity business, we are looking well in excess of that. I have not been able to find what percent of future earnings you expect them to be and what type of growth and how far out, as right now you are at about 20-25% annual EPS growth at Dow Ag. Going out 2009-2010 and beyond, to me 20% -25% EPS growth there seems sustainable if not surpassable. Accurate or not?

Andrew:
I think you are more accurate than not, remember the current % of Dow earnings is because AG is front loaded. It tends to be a first half year event for all of us because we are in the northern hemisphere and that's whether its Dow (DOW), DuPont (DD) or Monsanto (MON). The whole year happens in the first six months. We have some southern hemisphere exposure, notably Brazil and Argentina and my country Australia, but most of it is titled towards the northern hemisphere as a % of total earnings. Those numbers are distorted at this moment, but if you take the whole year and you say in '07 Dow AG earned about 10% to 15% of Dow's earnings but their growth rate was like you said, 20 some odd percent for the last five years.

They achieved that through 2 mechanisms one of which will continue to be a big plus that will ultimate if not continue that 20% ramp up it will get very close. The first mechanism is we have been levering Dow's considerable operational efficiencies over to Dow's Agroscience. Even though it is a small co. $3 to $4 billion in revenue, it has the power of a $50 billion co. in terms of operational excellence in its manufacturing, plants and supply chain. In its governance and share services it operates with its access to big company infrastructure, that's number one.

That's helped a lot of the cost line. Number two, the most exciting part is its pipeline. I mean, four years ago we made a conscious decision we said,"look, we're never going to be a big seed co. because its too expensive, one of these days we might be able to find an answer on U.S. corn, but between now and then let's rev up the technology engine and frankly not just in bio and seeds and traits in germplasm, but also in crop chemicals." I don't care what people say, GMOs will not replace crop chemicals in totality because growers will always need variety in their toolbox, its about diversity of solution and biotech cannot answer everything.

So we said "let's put R & D in focus on the pipeline that we now have" in crop chemicals in particular things that are not just in corn, but outside of corn, in cotton, rapeoil and canola, in seed ,in soy beans and of course over range and pasture. The crop chemical R & D pipeline we have right now and what we have done in traits, and in particular our new traits that we have announced plus the SmartStax agreement with Monsanto, have put us in a tremendous position. By 2010 when SmartStax gets launched, when our new traits get launched and our crop protection pipeline comes through, the R & D engine will yield real margin expansion for Dow AG.

I happen to think that Dow Ag in many ways doesn't need to have big revenues because its margins at 16%, 18%, 20% bottom line margins is packing a big punch in terms of its ability to deliver margin despite its size. We're increasing the R & D spending there. Dow Ag has a quarter of the R & D spending as a company which is a phenomenal statement when considering the size of the company we are and out there in the future Todd, we might be able to find rationalization opportunity and I will say out there, we'll find another one. In the meantime keep making that growth story.

Todd:
That was actually the next question. Ag sector valuations are stratospheric just now.

Andrew:
Oh yeah, I mean look, what were seeing now of the whole food change now started by corn and ethanol, that whole thing. Having said that, we're seeing China, this whole point about China's surge and as the Chinese eat more protein, eat more animals, those animals have to be nutured on agriculture, agriculture comes from feed, feed comes from corn and you know, there you go.

The food price things is real because of China's assention and I do think that's going to get worse before it gets better and I think the world is going to have to address it. I do not know what the systems will be. I do think the poverty side of it is big. The agricultural sector and the commodity boom in agriculture is compelling valuations to stratospheres, I mean Monsanto is the great flag carrier there, they are doing great and it wasn't long ago they were on their knees.