Olam

DMG & PARTNERS RESEARCH on 29 Jan 2013

OLAM will be releasing its Q2 FY13 results after the market close on Feb 7, 2013. Indications point to continued good volume growth for the food business.

However, we believe weakness persisted for the industrial commodity space, on the back of weak global economic growth and therefore soft demand for wood and cotton.

With Olam having secured five- year tenure debt funding of US$750 million, debt maturity is extended and liquidity improved. However, this comes with additional interest costs.

We are lowering our FY13 forecast and FY14 forecast earnings by 11 per cent and 18 per cent respectively to reflect the higher interest costs and likely weaker growth from a slower pace of acquisitions.

We roll over valuation to 10x FY14 EPS (from 12x FY13 EPS previously), and derive our new TP of $1.97. Our target PE is a discount to the historical average of 17x. We remain positive on the long-term prospects for Olam and believe investor interest will return as earnings continue to grow. Maintain "buy".

Higher interest expenses contributed to cut in earnings forecast. The effective bond cost is 8.08 per cent (or US$61 million) per annum, which factors in the 6.75 per cent coupon and 5 per cent initial discount.

We raised our FY14 forecast interest expense by 13 per cent to $626 million to reflect higher interest from this bond as well as possible future issuance of bonds to replace maturing ones.

In addition, we lowered our operating profit forecast to take into consideration a slower pace of acquisitions. All these contributed to our FY14 forecast net profit cut of 18 per cent.

Temasek's presence as a significant shareholder is a major positive. Temasek's stake in Olam equity and in the Olam bonds will go some way to allay investors' concerns on Olam's gearing and liquidity. Some investors are concerned with Olam's net gearing of 2.0x. But we note that the adjusted net gearing is 0.57x (adjustment for liquid assets).

Longer-term growth remains sound. Olam recorded a three-year (FY09-12) net contribution CAGR (compound annual growth rate) of 32 per cent, with the food CAGR of 38 per cent offsetting the weakness for the industrial raw materials. Food continues to form the bulk and accounted for 87 per cent of FY12 net contribution.

We remain optimistic on Olam's growth potential from this food space, which we believe remains unchanged despite the recent spate of developments. This is a key driver to our "buy" recommendation.

BUY