Growth opportunities abound. The global economic turmoil has presented Olam with organic and inorganic growth opportunities. The group has been expanding its market share at the expense of weaker competitors who have been ousted as a result of the credit crunch and economic downturn. At the same time, distressed assets have emerged following the financial meltdown, presenting the group with M&A opportunities. Management has articulated its interest to pursue bite-sized acquisitions, but remains cautious to contain its gearing levels.
But gearing is relatively high. Olam's key weakness, in our view, is its high gearing ratio. It is more heavily geared than its peers, with total debt to equity ratio of 4.67x, substantially higher than its peers, whose gearing ratios range from 0.48x to 1.38x. Even after adjusting for its hedged inventories and receivables, gearing remains above that of its peers'. The group's reliance on debt could pose refinancing risks in the event of a protracted credit crunch. Rising interest costs could also erode profit margins should the group find itself unable to pass on these higher costs to its customers.
Valuations near historical trough; initiate with BUY. The equity market meltdown has brought Olam down to its trough valuations. We see value is emerging at current levels although the volatility could persist in the near term. Olam's key investment merit lies in its resilient earnings growth profile against a climate of earnings contraction. We initiate coverage on the stock with a BUY rating and S$1.37 fair value estimate based on 10x FY10 PER. Key risks include high gearing, counter-party risk, and dilution risk from its convertible bonds.
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