Agria Sales to Fall

Expect Agria's Sales to Fall in 2009
 
Agria Corp's (GRO - Analyst Report) financial performance through the first nine months has been hampered by significantly lower seed prices and a disruption in production of sheep-breeding products. We would not categorize the cause of either to be inherent fundamental issues that would be expected to affect sales for the long-term.

Sheep-breeding revenue should continue to rebound in the fourth quarter and into 2009. While corn seed prices will likely remain depressed until the excess inventory in the market is consumed, we do not expect this to be a protracted event.

Of greater concern is the global economic slowdown and how it will affect sales, profitability and cash position in 2009 and possibly into 2010. Arrangements such as upfront payments to suppliers to fund the growing and harvesting season (which is then recouped when Agria buys the product) leaves the company exposed to a poor harvest or otherwise cash-strapped suppliers. Sheep-breeding revenue, while expected to recover from slow sales in the first half of 2009, may also fall relative to 2007 as demand falls due to the global slowdown.

Concerns we have that are fundamental to the company are those of governance, controls and transparency. While Agria has taken some steps to make improvements (set-up Board of Directors of and strengthened control over P3A), there’s clearly significant work to be done. Until these issues have been satisfactorily addressed and remedied, we would recommend caution before investing in the shares.

There are reasons for investors to be interested in Agria, however. They offer unique and proprietary products to a very large market that is all but void of foreign competition. China prohibits foreign ownership of sheep-breeding businesses and limits foreign ownership of any Chinese seed company to 50%. Agria’s gross margins of around 50% provide it with substantial cash and significant resources to reinvest in the business for future growth. The company has a large cash position with virtually no debt, a portion of which they plan to use to buy back stock. The company recently implemented a stock repurchase program authorizing up to $10 million in stock buybacks over 24 months.

While we believe the company has the potential to significantly grow sales and EPS, especially into the next decade, we remain concerned about controls and transparency. We expect slower sales in 2009 relative to 2007 as a result of continued depressed corn seed prices and slightly softer sheep breeding sales due to global economic weakness.

Sales should continue to rebound from 2010 through 2012 with net income bolstered by operating margin improvement and modest share repurchases. However, until the governance, control and transparency issues are resolved we do not expect the shares to outperform.