Corteva Stock: Disinflation Is A Headwind (NYSE:CTVA)

Investment Thesis

Corteva (NYSE:CTVA) was spun off from DuPont (DD) in 2019 and the company has been performing well. Its share price has increased by over 120%, significantly outpacing the S&P 500 index (SPY) which only grew slightly over 50%. Unlike most companies that struggled last year due to soaring inflation, it actually benefited from it. Due to the Ukraine-Russia war, the supply of agricultural products has been tight, which provided strong support for pricing. However, the tailwind is fading as inflation is starting to slow down. The company’s latest earnings result is solid due to price increases, but guidance suggests growth slowing down in the coming year as disinflation takes place. The current valuation also isn’t cheap, considering slowing growth. I do not see much further upside, and I rate CTVA stock as a hold.

Why Corteva?

Corteva is a leading agricultural science company formed in 2015 under DuPont, before spinning off in 2019. The company provides solutions for seeds, crop protection, and biologicals. It offers higher-yield potential seeds to farmers through its two seed brands, Pioneer and Brevant. It also provides crop protection products that protect fields from weeds, insects, and diseases. The biological segment offers natural materials such as enzymes that can put specific benefits in farmers’ fields, for example, managing pests or enhancing plants’ health. The company is able to offer best-in-class products through heavy investment in innovation and technology.

Seed and crop protection both have a huge TAM (total addressable market), although it is growing relatively slowly. According to the company, the TAM for seed is estimated to be $30 billion while growing at a CAGR (compounded annual growth rate) of 2.5%. The TAM for crop protection is $65 billion, while growing at a CAGR of 4%. Most of the expansion is driven by increasing food consumption and higher sustainability requirements.

Biological is another emerging opportunity worth noting. It is one of the fastest-growing markets within the agriculture industry. Its TAM is estimated to grow from just $9 billion in 2021 to $30 billion in 2035, representing a CAGR of roughly 9%. Corteva has been trying to increase its footprint through acquisitions. It acquired Symborg and Stoller, two biological companies, last year which should help enhance its offerings. I believe this segment will be a strong growth driver moving forward.

Q4 Earnings

Corteva announced its fourth-quarter earnings last week and the results are solid thanks to price increases. The company reported revenue of $3.83 billion, up 10% YoY (year over year) compared to $3.48 billion. The growth was mostly driven by the seed segment, which reported revenue of $1.65 billion compared to $1.39 billion, up 18% YoY. Revenue for crop protection was $2.18 billion, up 4% YoY from $2.09 billion. The overall strength was led by pricing, which increased 12% YoY, while volume actually declined 1% YoY.

Thanks to a better pricing mix, the operating EBITDA margin increased 214 basis points from 7.5% to 9.7%, resulting in operating EBITDA up 41% YoY from $262 million to $370 million. The operating EPS was $0.16 compared to $0.08, up 100% YoY. But this may not be comparable due to significant differences in tax rates. The company initiated guidance for FY23, and it is shy of consensus, with revenue growth of 5% and operating EBITDA growth of 9% at the midpoint. Corteva’s balance sheet is extremely strong as it ended the quarter with $3.2 billion in cash and only $1.3 billion in debt, which provides ample flexibility for buybacks, dividend increases, or acquisitions.

The report is solid, but it also signals the risk of disinflation. The company is showing strong revenue growth, but it is basically all driven by price increases. As inflation tames, this tailwind may suddenly turn into a headwind. CPI (consumer price index) has been trending down in the past few months, down from 9.1% in June last year to 6.5% in January. The figure is expected to go down further over the coming year. It will be much harder for the company to maintain its price increases in the near term. This is somehow reflected in the lower-than-expected guidance, but I think the disinflation forces may be stronger than expected not to mention the likelihood of a recession, which could further impact revenue growth.

Investor Takeaway

Corteva has strong fundamentals, but I am staying away from it for now. The company relies heavily on pricing for growth, but the inflation tailwind is now fading. Supply may still be tight, but demand is also slowing as the economy starts to weaken. Due to tough comps, it will likely see a slowdown in growth this year (guidance indicates 5% growth for FY23, compared to 15% in FY22). In my opinion, the guidance is not strong enough to support its valuation. It is currently trading at an EV/EBITDA ratio of 13.61 which is not cheap for a company expecting to grow revenue at just mid-single digits. This also represents an 11.8% premium compared to its own historical average of 12.61x. Given the disinflation headwind and recession risk, I do not think there is further upside potential. Therefore, I rate the company as a hold.