UOB Kay Hian 2015-08-31: Olam International - Confidence Boost.

OLAM INTERNATIONAL LIMITED O32.SI

Confidence Boost

Mitsubishi Corp (MC) is taking up a 20% stake in Olam by subscribing to new shares and purchasing from the founding family at S$2.75/share. This is a confidence boost with MC paying a premium for its stakes.
We are positive on this, as it allows Olam to leverage on MC’s strong processing capability and consumer base in different markets. This JV is likely to allow Olam to save on capex to start downstream operations in markets such as the US and Japan.
Upgrade to BUY, pegging to mean PE. Target price: S$2.30.

We are turning more positive on Olam with the entrance of Mitsubishi Corporation (MC) as its new strategic partner with a 20% stake at premium pricing. We are expecting medium-term value enhancement from this new partnership as:
1. Olam will be able to tap on MC’s growth in food processing, and
2. MC will be able to provide the processing capability and developed markets access for Olam.
This is likely to lead to earnings enhancement and capex saving.

Olam announced a strategic partnership with MC with the issuance of 332.73m new shares to MC at S$2.75/share to raise S$915m. MC will also acquire 222.0m secondary shares from the Kewalram Chanrai Group (KC), and was transacted at the same price as well, according to Olam’s management. Post-exercise, MC will hold 20% stake in Olam and Temasek’s stake will be diluted from 58.39% to 51.39%. MC will also appoint up to two executives to serve on Olam’s board.

Olam and MC will establish a JV in Japan to handle coffee, cocoa and edible nuts and will continue to supply customers with sustainably-produced processed foods. This will be a good platform for Olam to leverage on MC’s manufacturing, distribution and retail presence in Japan. MC also has stronger presence in other Asia markets.
The JV agreement will be finalised within 120 days and management will then provide more detail on the potential synergy value. A partnership with MC is not new for Olam, as MC had acquired an 80% share of Olam’s grains company in Australia in 2014.

agreed price of S$2.75/share translates into 2015F/2016F PE of 23x/21x and P/B of 1.6x/1.4x. This price is higher than the general offer price by Temasek of S$2.23/share back in 2014 and also higher than our previous fair value of S$1.90. We deem this as a very good premium pricing that Olam’s management has been able to lock in and boost up its capital.

The new shares issued will enlarged by 13.6%. The enlarged share base will have an estimated 11% earnings dilution but neutral to book value.

Both parties have different areas of strength in terms of capability and market accesses which both can leverage on in order to create cost and revenue synergies. For example:
1. Olam will be able to penetrate into more developed markets with minimum capex by leveraging on MC’s existing processing plants,
2. MC owns the world’s largest coffee plantation in Brazil while Olam is one of the top coffee traders, and
3. Olam will be able to leverage on MC’s North America edible oil processing plants for its palm oil from Gabon.
Management is not ready to share the value of the synergies yet, as they are pending the finalisation of the JV agreement within the next 120 days.

The total capital of S$915m raised will be used for expansion capital. Post-transaction, Olam’s net gearing will decrease from 1.9x to 1.4x (management’s gearing target: significantly below 2x). Expansion capex could see some savings from the partnership with MC as Olam will be able to leverage on MC’s processing plants and network to grow in new markets.
The institutionalising of the shareholding structure with reputable and strong strategic shareholders is positive and will improve market confidence in terms of better corporate governance and transparency. This should translate into better valuation.

Marginal adjustment to our 2015/16/17 net profit forecasts to reflect higher interest income from the new capital injection. We have yet to factor in any synergy from this partnership pending more information regarding the areas of cooperation upon execution of the JV agreement. Thus, there could be upside to our 2016-17 earnings forecast.

Upgrade to BUY, with a higher target price of S$2.30 (previous: S$1.95), which is based on higher PE of 16.2x (10-year mean) on 2016F fully diluted EPS (up from 11.2x PE based on -1SD from mean PE). We like the stock’s medium-term prospects because:
1. return of investor confidence with two reputable strategic shareholders,
2. volume growth in medium term should be boosted by leveraging on MC’s strengths, and
3. the business structuring that has been taking place since two years ago is showing positive results in terms of margins improvement.

Continued efforts to strengthen its balance sheet, ie improving free cash flow and lowering its gearing.
Market share and earnings enhancement M&A.

Singapore Research Team | http://research.uobkayhian.com/ UOB KH 2015-08-31

BUY Upgrade HOLD 2.30 Up 1.95