Olam International

Kim Eng on 13 June 2012

Share price jumps on buyback mandate. Olam’s share price has jumped 11% since the company announced last Friday that it has commenced a share buyback programme. While such a move is usually a positive sign, the circumstances for Olam seem rather unusual. Fundamentals-wise, other than to deter the short sellers, we do not think it is necessarily an enhancive step for shareholders.

Borrowing money to purchase shares. The case for a share buyback is stronger for companies with piles of idle cash coupled with strong operating cash flows. Olam, however, is considered highly leveraged with net gearing of 189% and adjusted net gearing of 42% as at FY6/12. Since listing in 2004, its operating cash flow has been positive only in 2006 and 2009 as funds were needed for expansionary working capital.

Beware sudden gifts. Essentially, a company has two ways to reward shareholders – share buybacks or dividends. Olam’s dividend payouts have been similar to peers but were hardly generous, at about 25% of profit since FY6/08. Assuming a full exercise of its share buyback mandate at the last transacted price, this would represent an outlay of SGD397m, close to its entire dividend outlay since its 2004 IPO.

Belies Olam’s dependence on equity market. Share buybacks also do not present any tax advantages in Singapore’s context. Arguably, therefore, raising dividend payout may be a better way to build longterm shareholder value, though a stock buyback may provide a boost to share price. We think this actually belies Olam’s dependence on the equity market for its M&A growth strategy. Since adopting this strategy in FY6/07-08, it has done six equity-linked fund-raising exercises.

No compelling value yet. Olam is trading at the lower end of its historical range, but 1.5x P/BV would hardly qualify as below its intrinsic value, conservatively calculated; a criterion Warren Buffett once cited as advisable for a company to repurchase its own shares. We think the market may have overreacted to news of the buyback and maintain our SELL call with a target price of SGD1.43, pegged at 1.2x P/BV. We continue to see earnings risks amid lingering macro headwinds.