The S$720m of CBs issued by Olam last week will result in a 12% equity dilution upon conversion. But together with the S$778m of syndicated debt in place, the Group needs only a 2.4% ROI to offset this impact. Compare this with the 6.4% ROI being generated by their past acquisitions in FY09; a year characterised by macro pressure. The Group’s new businesses generate a net contribution per tonne that is 90% higher than its legacy businesses, pointing to the success of Management’s strategy of exploiting sectors that can generate excess returns. Indeed, we expect a similar play as Olam deploys its new funds as part of its 3-year strategy.
A key part of Olam’s new strategy is to be fully integrated across the value chain for coffee, African palm and nuts. Expect the first wave of acquisitions to come through here in upstream plantations and midstream/ downstream facilities. Indeed, upstream players generate PAT margins of ~15% and downstream players 8%, compared to Olam’s 2%; so these acquisitions will be key in realizing Olam’s own goal of doubling PAT margins by 2015.
We are less sanguine on Olam’s foray in to financial services, particularly funds management, where there is no track record. Indeed, even the fee businesses may result in higher earnings beta. Noble who offers similar services has seen their GP margins vacillate from 30% in FY04 to 7% in FY08.
We conservatively assume funds deployment will come through in FY11 and we expect the Group to generate at least similar ROI to its past investments. While we keep our base forecasts unchanged pending deployment, such a blue-sky scenario will increase FY11-12 earnings by 44-47% and our DCF and peers based fair value to S$ S$4.60 – 92% upside on a fully diluted basis.
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