The Dow Chemical Company’s (NYSE:DOW) agricultural science products business primarily deals in crop protection products, such as insecticides and herbicides, and genetically modified (GM) seeds. The division contributed more than 11 and 17% to the company’s total sales and earnings before interest, tax, depreciation and amortization (EBITDA) in 2012. We believe that the division has a significant potential to tap into the growing demand for agricultural products based on its existing commercial line up and products that are pending regulatory approvals. According to our estimates, the division contributes ~15% to the company’s total value. 
Dow is a diversified chemical industry giant operating in specialty chemicals, advanced materials, agro-sciences and plastics business segments. It delivers a broad range of technology-based products and solutions to customers in approximately 160 countries, and in high growth sectors such as electronics, water, energy and agriculture. In 2012, Dow reported annual sales of approximately $57 billion earning adjusted net income of around $2.6 billion.
Our $37 price estimate for Dow Chemical is almost 5% below its current market price.
Growing Demand For Agricultural Products
We see a huge growth potential in the agricultural products market, primarily due to the growing adoption of genetically modified (GM) seeds for higher yields and better traits. The rising global population and declining availability of arable land, both point towards higher demand for more sustainable technological solutions for the agriculture sector. GM seeds provide farmers with higher yields, lower susceptibility to insects, increased tolerance to chemicals used for eliminating weeds (herbicides) and extreme climatic conditions such as drought. As a result, farmers in developed countries have largely adopted GM seeds. GM corn varieties make up ~90% of the total corn planted in the U.S. 
The global agricultural area under biotech crops grew to over 420 million acres in 2012 from just 4.2 million acres in 1996.  It should also be noted that according to the estimates of the food and agriculture organization (FAO) of the United Nations, GM crops still make up just over 3% of the global agricultural area.  This implies a significant upside potential for GM seeds adoption even if we assume that their global penetration would approach just about half of what it is in the U.S. today (about 50%). 
However, there are some concerns regarding the potential negative impact of GM crops on consumers’ health and global environment. Various consumer rights and other non-governmental pressure groups have raised these concerns, which has led to the creation of several legal and regulatory hurdles for GM food product manufacturers. The adverse impact of pesticides on the environment, including animal species and humans, is another concern for regulatory bodies, which could potentially prevent the commercial usage of certain new crop protection products.
Dow Chemical’s Position In The GM Seeds Market
Although GM seeds make up just around 20% of Dow’s total agricultural products sales, these are expected to be the primary growth driver for the division’s top line going forward, because of a relatively high growth potential and the company’s strengthening position in the segment. 
According to our estimates, Dow has been able to expand its share in the global agricultural products market by more than 100 basis points since 2010 on the back of a very successful launch for Smartstax seeds brand. We believe that the Enlist weed control system, which is pending regulatory approvals in the U.S., could provide another boost the company’s market share in the coming years.
SmartStax: It is a brand of GM seeds developed by Dow in collaboration with Monsanto that takes advantage of multiple modes of insect protection and herbicide tolerance by stacking multiple traits together. SmartStax has eight GM traits combined or ‘stacked’ together, two for herbicide tolerance and six for insect resistance. These traits were combined through the conventional breeding processes instead of the genetic transformation of a single strain.
First commercially planted in 2010, the brand contributed significantly towards increasing volumes by 27% y-o-y in 2011 for Dow Chemicals’ seeds, traits and the oil business. Its success in 2012 was reflected in more than double technology sales as compared to 2011, driven by the introduction of POWERCORE (an extension of the SmartStax family that contains five traits, two herbicide-tolerant genes plus three genes resistant to pests) in Latin America and REFUGE ADVANCED (a blend of 95% SmartStax corn seed and 5% refuge (non-Bt) seed that farmers can plant across their entire field) in North America. 
Enlist Weed Control System: This system targets the herbicide tolerant crops market, which makes up more than 60% of the total GM crops market today. The segment is dominated by Monsanto, the leader in GM seeds market, which introduced the most successful and widely adopted product in the form of Roundup Ready weed control system in 1996. The system comprised of seeds that were genetically altered to tolerate glyphosate-based herbicides. Modified genetics ensured that the glyphosate-based herbicides, which were effective on a broad spectrum of weeds, did not harm the crop. 
However, with weeds growing tougher and increasingly resistant to glyphosate-based herbicides, there is a market need for another mode of precaution to sustain and further grow crop yields. According to a third-party research conducted by Dow Chemical, cropland acres with weeds resistant to glyphosate based herbicides increased around 50% in 2012 alone and around 80% over the last two years, to reach over 65 million acres. 
The Enlist weed control system includes seeds that are genetically modified to tolerate the new herbicide from Dow, Enlist Duo. This herbicide contains 2,4-D that adds another mode of action to the glyphosate-based herbicides. The technology aims at providing higher crop yields through better protection against tougher weeds, which have been growing resistant to the glyphosate. Commercial application of the system requires both the new seed traits as well as the new herbicide to be approved by the regulatory authorities. 
In terms of competition, Monsanto has developed another herbicide tolerant system called the Roundup Ready Xtend Crop system, which uses the new Roundup Xtend herbicide. The Roundup Xtend herbicide adds dicamba as an alternate action to the glyphosate-based Roundup herbicide. This herbicide will have to be used with Roundup Ready Xtend seeds that can tolerate the application of dicamba as well as glyphosate. 
However, there is considerable opposition against the use of both these weed control systems, which has led to extended reviews by the U.S. Department of Agriculture (USDA). Dow initially planned to launch Enlist corn for the 2013 planting season but pending regulatory approvals have delayed the launch by almost two years. These approvals are also delaying the launch of Enlist products in Canada, where the company has already received regulatory approvals for launching Enlist corn and soybean seeds as well as the use of Enlist Duo herbicide. 
Because of the shear size of the herbicide tolerant crops market, a successful product that can potentially replace the existing Roundup Ready system can significantly boost Dow’s market share in the GM seeds market. Moreover, the fact that Monsanto was the first one to get a license to Enlist herbicide tolerant trait from Dow indicates that the technology has a huge potential to capture value in the fast-growing GM seeds market. (See: Dow And Monsanto Deal Sets The Stage For Next Generation Of GM Seeds)Notes:
- Dow Chemical SEC Filings, sec.gov [↩] [↩]
- Adoption of Genetically Engineered Crops in the U.S., ers.usda.gov [↩]
- Global Status of Commercialized Biotech/GM Crops: 2012, isaaa.org [↩]
- Genetic Engineering and Biotechnology, globalagriculture.org [↩]
- Acreage 2013, usda.gov [↩]
- 2012 Dow Annual Report, dow.com [↩]
- Herbicide Tolerance Technology: Glyphosate and Glufosinate, isaaa.org [↩]
- Bank of America Merrill Lynch Global Agriculture Conference, dow.com [↩]
- Enlist Weed Control System, enlist.com [↩]
- Roundup Ready Xtend Crop System, monsanto.com [↩]
- USDA says more review needed for new Monsanto, Dow GMO crops, reuters.com [↩]