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Investor CentralOlam International Ltd - Is the debt level sustainable - which of the brokers is right?
18/2/2013 – Olam International says it is "recalibrating its strategy" over the next three months.
Meantime, analysts are divided over whether its current debt level is sustainable, and the stock has barely moved in the days after it announced its Q2 earnings:
Revenue: +9.2% YoY to S$4.9 bln
Net contribution (NC): +19.1% to S$422.9 mln
Profit: -1.4% to S$151.3 mln
Exceptional items: S$18.1 mln vs Nil
Cash flow from operations: S$114.7 mln vs (S$291.1 mln)
Debt repayable in the next year: S$3.79 bln
Debt repayable after one year: S$5.04 bln
Olam’s revenue was higher due to increased volumes for all segments except for confectionery & beverage ingredients, where a shipment delay resulted in lower volumes.
It sold and leased back 4,795 acres of almond orchards in California.
This released S$69 mln in capital and resulted in a one-time net gain of S$18 mln.
Excluding this one-time gain, net profit would have been S$136 mln, up 6% YoY.
Few brokers feel that Olam’s gearing level is too risky, while OSK DMG believes there is still room to borrow more money as the threshold is not yet reached.
Bullish analyst report
DMG OSK Research says the improvement in net contribution largely came from food staples and packaged foods and industrial raw materials segments.
While the share of net contribution from industrial raw materials of 16% is much lower than the 88% for food, it views the improvement in margins for cotton as a big positive for the industrial raw materials segment.
In addition, Olam’s net gearing of 2.21 times is higher than the June 2012 level of 1.81 times, but remains lower than Olam’s internal limit of 2.5 times.
Adjusted for liquid assets, Olam has a net gearing of 0.68 times.
Management indicated it has sufficient liquidity to meet all financial obligations till end FY14.
Hence, the house maintained its BUY rating with a target price of S$1.97.
OCBC Research says the first half of the year tends to be weaker, hence the results met its expectations even though they were less than half of their full year estimates.
They view the recalibration exercise as positive, but are not going to make any changes to their forecasts just yet.
OCBC maintains a HOLD call with a price target of S$1.50.
Bearish analyst report
Maybank Research says the net contribution growth was strong, similar to the previous quarter.
However, most of the growth came from the food staples and packaged food segment.
It understands this is primarily from growth in the grains business, in which volumes are big but the net contribution per tonne is usually low.
The analyst believes the weakness in profit continues to stem from the increasing debt and overhead loads.
Employee benefit expenses for the quarter were up 33% YoY, while finance costs continue to balloon, up 36% YoY.
To put this into perspective, finance costs of S$131.4 mln was not far off from net profit.
Net debt to equity went up significantly to 252%.
It further says that this risk continues to be front-loaded over the next 18 months with estimated capital expenditure of S$1.7 bln and S$3.9 bln debt to be repaid or rolled over.
On the announcement by management that it will "recalibrate its strategy", the analyst welcomes this move, but at the same time this suggests that existing strategy may be inherently flawed.
Maybank Research maintained its SELL rating with a target price of S$1.30 as it does not see any reason to own the stock, given the risk associated with refinancing in the next 18 months.
Meanwhile, Muddy Waters has also maintained its STRONG SELL rating and views Olam on liquidation basis.
It says Olam’s interest burden at 69.9% of operating cash flow is not sustainable.
It also highlighted that Olam realised a 70% gain on the sale of almond orchards in California but the lease term is fairly burdensome to Olam.
Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.
Does it have any capacity to take on more debt?
Olam’s net gearing of 2.21 times remains lower than Olam’s internal limit of 2.5 times.
Even the adjusted net debt to equity of 68% was highest in Olam’s history.
To convince investors, management indicated that it has sufficient liquidity to meet all financial obligations till end FY14.
However, Muddy Waters Research believes that interest it pays on current debt is not sustainable.
Therefore, it makes us wonder whether Olam really has capacity to take on more debt.
2. Is the focus now on cash flow generation?
Olam initiated a strategy review to recalibrate its priorities and capital expenditure.
It conducted a sale and leaseback of its US almond orchard land, a move which freed up cash and helped the balance sheet.
Therefore it makes us wonder whether we expect more of such asset sales in the near future.
What is the expected increase in cost due to delay in the Gabon fertiliser project?
The Gabon fertiliser project has been delayed by nine months and is likely to face cost overruns.
Management said that contributions can be expected from FY17 onwards.
Muddy Waters Research says that Olam has not even signed the construction contracts yet.
The only work that has taken place is some dredging.
Hence, it views Olam’s expectations of project costs were unrealistic due to its inexperience in greenfield production.
We have sent these questions to the company to invite them for an on-camera interview, and/or seek their written response.
Sofar, we have not had a reply (which is why you are seeing this message).
Sources & further information
Statutory disclosure
Press release
Presentation materials
Muddy Waters Research Report
Maybank research report
OSK DMG Research Report
CIMB Research report
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