Olam - Armed and ready

We believe the key areas where Olam will deploy S$2bn of new funds will be in upstream plantations and midstream processing assets. Although last week’s CB issue is dilutive, together with the syndicated debt, Olam needs to generate only a 2.4% ROI to offset the impact, whereas their past acquisitions generate 6.4%. While our forecasts are unchanged pending deployment, in a blue-sky scenario assuming these investments will contribute at least as much as the past, we believe Olam’s fair value should be closer S$4.60 implying 92% upside. BUY.

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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Olam: Acquiring dairy farm operations in Uruguay

Acquiring dairy farming operations. Olam announced the acquisition of a 14.35% stake in New Zealand Dairy Farming Systems Uruguay (NZFSU), an operator of large scale Kiwi-style dairy farming operations in Uruguay. Olam will purchase this stake for a cash consideration of NZ$14.37m (US$9.88m). We rate this acquisition positively. However, given the uncertain outlook for the industrial raw materials segment (27% of total net contribution), we maintain out NEUTRAL call on Olam. Our S$2.48 target price is derived from DCF valuation.

NZFSU is on the way to be a major milk producer in Uruguay. NZFSU applies NZ’s high performing pastoral-based farming systems to extensive areas of Uruguayan farm land for dairy farming. NZFSU currently owns 36,300 hectares of dairy farm land. NZFSU produced 44.6m litres of milk in the financial year ended 30 Jun 09 and expects to produce 80-85m litres in FY10. When all its farms are developed by Jun 2012, NZFSU will supply close to 20% of milk produced in Uruguay.

The acquisition is in line with Olam’s Dairy Products strategy, which includes participation in dairy farming in low cost origins.

On Olam will issue US$400mn in seven-year 6% convertible bonds

Olam will issue US$400mn in seven-year 6% convertible bonds (with an upsize of US$100mn) at a conversion price of S$3.08/share. We estimate share dilution of 7.9-9.7% or PV liability of S$0.24-0.30/share in the event of non-conversion. We maintain our NEUTRAL stance on Olam as we believe continued capital dilution to fund capex and inorganic growth will remain an overhang. Note that Olam significantly underperformed post its previous CB issuance in June 2008.
Olam plans to raise funds again following the recent S$437mn equity dilution and S$940mn credit facilities last week. As the company shifts from an asset-light to an asset-medium model, we expect the pace of capital dilution to pick up along with its growing capex and working capital needs. We estimate that Olam’s current war chest stands at around S$1.6bn, which will likely go towards further inorganic expansion.

The issuance of convertible bonds (Exhibit 1) could save around S$12-18mn pa in near-term interest expenses. However, we look for dilution in the range of 7.9-9.7% of the implied share base. Olam already has some US$141mn in CBs at a conversion price of S$1.65/share. In the case of non-conversion, the new CBs could represent PV liability of S$0.24-0.30/share.

A positive facet of the issuance for Olam is the long-term financing arrangement as well as the lack of a put option for the bondholders.

Olam also announced the acquisition of a 14.35% stake in New Zealand Farming Systems Uruguay (NZFSU) for US$9.9mn. NZFSU (listed, with a market cap of US$69mn) has upstream dairy operations in Uruguay. In FY09F, NZFSU reported a net loss of US$45mn. Olam’s management expects NZFSU to turn profitable in a couple of years.

We believe that investors may be concerned about the relatively small size and minority nature of acquisitions, since they seem to be financial investments rather than strategic ones. 􀁺 Our NEUTRAL call stands, as we believe valuation is stretched and the shares are already pricing in near- to medium-term earnings growth. Further, the constant issuance of paper to meet capital needs is likely to remain an overhang.

Olam International Ltd: Shopping for distressed assets

Revives acquisitions pipeline. Olam International Ltd (Olam) has acquired the tomato processing assets of SK Foods, a California-based company which has filed for bankruptcy protection, for US$39m (~S$58m). The cash transaction will be funded internally and Olam will not assume any debt arising from the purchase. The acquisition is small relative to Olam's 9M09 cash position of S$390.5m. Furthermore, with the additional S$437m proceeds raised from its recent equity placement to Temasek, this is probably just the start of a series of acquisitions that we can expect from Olam in the near future.

Opportunistic acquisition reaps synergy. The acquisition is a bargain at US$39m vs. its replacement cost of US$130m. Assuming net profit margins of 5%-9%, the deal is priced at an undemanding 2.2x-3.9x PER. Olam expects this acquisition to accelerate its entry into the US tomato processing industry, given that SK Foods was a dominant player ranked 2nd among US tomato processors and top 5 globally. With a processing capacity of 1.5m tons, its output accounts for 14% of the US market share and 5% of the global market share. The acquisition is expected to reap synergies on several fronts. For instance, it not only enlarges Olam's customer base, but also allows Olam to cross-sell tomato products to its existing customers. Other synergies can be derived from shared overheads and new product adjacencies.

Earnings accretive in the further future. We do not anticipate significant near term financial impact from the transaction. The acquisition is expected to be earnings accretive only from FY12 onwards and is expected to generate revenue of US$200m per year with an EBITDA margin of 12%-13% in steady state, higher than the group's current EBITDA margin of 5%. The incremental revenue translates to 3.3% of FY09F revenue. We are keeping our FY09 and FY10 estimates unchanged. Olam's share price has more than doubled since March and is trading at 26.1x FY09F PER vs. the STI's 16x, after taking into account near term dilution from its recent equity placement. Current valuations no longer provide an attractive entry level, in our view. Nevertheless, given its enhanced prospect of inorganic growth, we are keeping our HOLD rating intact. We are raising our peg to 20x (from 17x) as Olam revives its inorganic growth plans, deriving a fair value estimate of S$2.37 (previously S$2.01).

Olam - Reactivating M&A pipeline, accelerating growth again

Olam is raising S$437.5 mn through the placement of 273.46 mn new shares to Temasek Holdings at S$1.60 per share, a 17.4% discount to 29 May 2009’s closing price. Post-placement, Temasek’s 13.76% stake is the second largest after Kelwaram Chanrai.

Olam's gearing should fall from 2.51x to 1.52x post the exercise, with adjusted gearing at 0.3x, versus 0.83x previously. Olam had cited an inadequate access to long-term funding as limiting the scope for M&A, despite a strong deal pipeline. With capital raised, Olam’s M&A initiatives have thus been reactivated.

We are pricing in S$1.3 bn of acquisitions by FY12E, with S$900 mn funded by debt, and have assumed a blended P/E of 15x, excluding synergies. After adjusting for the equity dilution, our EPS forecast rises by 3-4% through FY12E.

With medium-term growth prospects now likely to achieve Olam’s 25-30% earnings CAGR guidance, and another fund-raising unlikely in the next 18-24 months, we raise our DCF-based target price to S$2.70 (from S$1.95), and rating from Neutral to OUTPERFORM.

Olam International - Steady growth

3Q09 results in line with expectations. Olam International Ltd's (Olam) 3Q09 results were in line with expectations. Revenue slipped 4.8% YoY to S$2.3b on lower commodity prices, but this was partially offset by volume growth. Reported net profit surged 56.1% to S$87.0m, mainly due to non-recurring gains from the buy-back of its convertible bonds. Stripping off these gains, core net profit would still have risen by a credible 12.0% to S$62.4m. Olam's 9M09 core earnings have met 67% of our full year estimate. We are leaving our projections intact since 4Q is a seasonally strong quarter.

Steady growth in volume. Olam registered a 6% YoY increase in overall volume in 3Q09. Edible products, which made up 79% of the group's revenue, formed the backbone of this growth, while industrial raw materials succumbed to weak demand. This is not surprising, given the relative inelasticity of demand for food. Olam's various food segments registered volume growth in the range of 8% to 16% in 3Q09. Its Fibre & Wood segment, on the other hand, languished with a 16% YoY decline in volume handled.

Healthier cash flow. Commodity price disinflation eased working capital requirements and boosted Olam's cash flows. 9M009 operating cash inflow improved significantly to S$108.1m from an outflow of S$192.0m a year ago. 3Q09 saw a YoY decline in operating cash flow, but this was due to a later procurement season coupled with the late arrival of crops, which delayed payment to its suppliers to the current quarter.

Light at the end of the tunnel? There have been signals suggesting that commodities markets could be bottoming out. According to management, prices and trading volumes of commodities such as cotton, wood and dairy rebounded sharply in April and May, providing a glimmer of hope that recovery could be in sight. For now, however, it remains premature to conclude if the rebound is due to genuine improvements in fundamentals, or whether it is purely a case of inventory restocking, in which case the rally could be short-lived.

Upgrade to BUY. Having delivered a 16.6% growth in 9M09 volume, Olam is on track to meet its target of 16% growth in FY09 volume. Olam has been a laggard in the recent rally, and is now trailing at 13.5x FY10F PER vs. the STI's 15x. We believe that Olam will continue deliver consistent growth, and are raising our valuation parameter to 15x (from 11x), and fair value estimate to S$2.06 (from S$1.51). Upgrade to BUY.

Olam International Ltd: Takeaways from Vietnam plant visit

Robust demand for food will drive growth. We visited Olam International Ltd's (Olam) operations in Vietnam, where the group showcased its cashew, pepper and coffee processing facilities. Vietnam, which contributes 6%-7% of the group's volumes and revenue, is a key sourcing country for the group and houses its coffee, cashew, pepper, wood, rice and cotton operations. Olam projects continued growth in demand for edible agricultural commodities, which forms 79% of the group's revenue. In particular, cashew was identified as one of its key growth drivers, thanks to growing demand for cashew ingredients for use in products such as ice cream and chocolate. The group is setting up a new cashew processing plant in Vietnam (projected completion in 2H CY10), which will double its existing capacity and drive volume growth.

Strategic advantages in a fragmented industry. Olam operates in a highly competitive and fragmented industry. Nevertheless, it has created strategic advantages to differentiate itself from its peers. For instance, it has obtained internationally-accredited food safety certifications such as the HACCP and AIB certifications which are required by US food makers. In addition, its ability to customize products according to customers' specifications and its track record of delivering consistency has helped to build customer loyalty. We believe that these are some of the factors that have enabled Olam to clinch long term contracts with well-established brands such as Nestle and Kraft, and these will empower the group to gain market share from weaker competitors.

Maintain HOLD ahead of 3Q09 results. Olam will be announcing its 3Q09 results on 14 May 09. Details worth paying attention to include its volume growth, as well as its gearing and working capital requirements, which we expect should ease given the environment of falling commodity prices. We are keeping our earnings estimates intact and believe that management's guidance for a 25% growth in FY09 earnings remains achievable. We see merit in Olam's resilient earnings growth profile amid a recessionary environment. However at current levels, positives appear to have been priced in given that Olam trades at a relatively expensive 15.0x FY09F PER (vs. peer Noble Group Ltd which trades at 7.4x PER). In addition, in view of the recent share price appreciation, we maintain our HOLD rating on the stock. Our fair value estimate remains at S$1.51.

Olam - Depreciation to kick-in 3Q08

According to Management, the Group’s key commodity segments are all performing well in 3Q08. In coffee, Olam is seeing significant growth coming from their Arabica business especially in intra-country sourcing and delivery in Brazil. In sugar, the Group has been successful in enhancing volumes to the CIS. Dairy along with the high-end timber business are continuing to see weakens. Overall, in light of these new data points we believe our initial volume assumptions are too light. As a result, we have raised our FY09 volume growth assumptions from 10% YoY to 20% YoY.

Depreciation for Queensland Cotton is charged on a USD per bale basis and the ginning season is set to begin in late 3Q08. Consequently, we expect depreciation to rise by 4x HoH in 2H09. Separately, the Group has added headcount. As a result, we expect opex to grow 15% YoY in FY09.

Olam’s peers trade at 14x FY09 earnings post the recent rally. We ascribe a 20% valuation premium to Olam for superior Management quality. However, we estimate that to reach 16x FY09 earnings the Group will need to deliver 32% YoY FY09 volume growth; the highest in the Group’s listed history. Or at current volume assumptions, net contribution per tonne will need to improve 10% YoY. With the company’s shift towards lower margin intra-country trade and softening commodity prices, we believe the likelihood of this is low.

We raise our FY09-11 earnings assumptions by 18-25% to reflect our higher volume expectations. Nevertheless, trading at 19x FY09 earnings and a 1.6% yield vs. 14x and 4.5% for the Singapore market, we argue the stock is overvalued. Our new DCF and peer valuation based target price of S$1.03 (up from S$0.88) implies 36% downside. SELL.

Olam - Cashew slowdown offset by market share gains

According to a recent article from Vietnam Business Finance , Vietnam, the world's largest cashew nut exporter, expects a 10% decline in overseas shipments this year because of lower demand amid the global recession. The article cited the president of the Vietnam Cashew Association who indicated that export of the nut, which accounted for 11% of total agricultural exports last year, may reach 150,000 tons in 2009. Orders in February have slid about 50% from a year earlier, and export prices may fall 30% this year. While low-quality cashews account for a large part of the country's crops, customers have ordered mostly high-quality nuts in the first two months of 2009, further damaging sales.

Cashews are one of the 17 primary food raw materials (out of 20 products in its portfolio) and Olam highlights demand for these products are reasonably resilient to recessionary conditions. Cashews are a major product for Olam and is categoried within the Edible Nuts, Spices & Beans segment of their business (13.6% of group sales; 18% of net contribution for 1HFY09A). Cashews account for about 30% of volumes within this segment. Our checks with Olam indicate that Vietnam is experiencing a short crop this year and they think the volume drop could be due to this. In 1H09 (ending Dec 08), Olam's Edible Nuts, Spices and Beans business saw volumes increase 28.8% yoy, revenues up 23% yoy and net contribution up 39.4% yoy. Olam has a global market share of 17% for Cashews and is not affected as they are still gaining market share and volume growth in Vietnam given their diversified sourcing in 15 origins, their own processing operations in key origins and marketing presence across Asia, Oceania, Middle-East, Europe and Americas.

Olam International Ltd: Gravity-defying growth

Resilient to recession. Olam International Ltd (Olam) has been delivering consistent revenue and earnings growth since its listing in 2005, and growth momentum is expected to sustain despite the global recession. Management has guided for 16% to 20% topline CAGR and 25% to 30% earnings CAGR over the next three years. These goals are achievable, given that demand for food is relatively inelastic and earnings are therefore less vulnerable to the global economic downturn. Olam has already proven its resilience by delivering a 32.9% growth in 1H09 core earnings despite the recent collapse of commodity prices, demonstrating its ability to perform under difficult conditions.

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.

Olam International Ltd - Convertible bond exchange details

On 16 Feb, Olam had announced a convertible bond exchange offer at 78cts to the dollar. While the bond returns are not significantly different, the share conversion price for the new bonds are significantly lower, signalling management's keenness to place out new shares at S$1.656. The exchange would result in lower debt and higher interest expense. About 77% of the existing convertible bond holders have accepted the exchange offer. We view the exercise as non-core and maintain our core EPS estimates. Our FY09-11 reported EPS estimates, however, have been adjusted by +19% to -9%. We believe that the conversion price will serve as a price ceiling in the near term. Our target price remains S$0.97, based on 6.4x CY10 P/E. Maintain Underperform.