Olam International - DBS Research 2017-05-16: Holding Tight

OLAM INTERNATIONAL LIMITED O32.SI

Olam International - Holding Tight

1Q17 core profit up 4% y-o-y, in line with expectations.
Strong contribution from Edible Nuts and Food Staples divisions.
Positive free cashflow stronger in 1Q17, on track to achieve positive free cashflow to equity by year end.

We maintain our HOLD call on Olam International (Olam) with a revised TP of S$2.15.
Olam appears to have successfully integrated the US$1.2bn acquisition of ADM Cocoa, and is on track to achieve positive free cash flow to firm/equity by the year end. However, with limited upside to our TP, we believe the stock will remain range bound.
In addition, with return on equity (ROE) still suboptimal, a re-rating beyond its average PE multiple of 16x implied by our TP is unlikely at this stage.

Consensus has sell ratings on Olam, which we believe is unwarranted.
While Olam faces the challenges of declining cocoa prices and softer cocoa processing margins this year and still generates suboptimal returns, we believe the company should deliver decent EPS growth this year, given strong performance from Edible Nuts and recovery at its Food Staples division.

Despite our cautious stance on Olam’s near term share price performance, we remain positive on Olam’s long term outlook.
Currently, Olam has S$5.1bn worth of immature assets which on maturity, could generate an additional c.S$0.76bn-1.26bn of EBITDA. All these factors may enable Olam’s share price to re-rate closer to S$2.23 and S$2.75 in the medium term, price levels at which Temasek and Mitsubishi acquired their most recent equity interests in Olam respectively.

On the back of higher profits from the redemption of its 7% perpetual securities, we raised our TP to S$2.15 from S$2.12.
Our TP is a blend of our PE valuation of S$2.16 and our DCF valuation of S$2.15.

The key risk to our neutral stance is a faster than expected delivery of earnings from Olam’s gestating/immature assets.
On the downside, with gearing in excess of 1.5x, Olam’s earnings are vulnerable to a significant rise in interest rates.

1Q17 core profit (excluding exceptional, biological losses and after perpetual dividends) rose 4% y-o-y to S$132.7m which was in line with expectations.
The growth in core profit was largely attributed to increased contribution from the Edible Nuts and Food Staples divisions, partially offset by higher interest costs and coupon payments post the issuance of additional perpetual securities in 2H16.
Meanwhile, Olam continues to make good progress on the cash flow front. It generated positive free cash flow to firm (FCFF) of S$135m, an improvement from –S$156m in 1Q16. In addition, free cash flow to equity (FCFE) improved to –S$42m versus –S$284m in 1Q16.
Olam appears to be on track to achieve its target of positive FCFE by year end.

The Edible Nuts segment had a strong start to the year with EBITDA rising 72% y-o-y to S$138m. This was underpinned by 23% y-o-y growth in volumes.
In addition, the segment benefited from the acquisition of Brooks Peanuts, recovery in Almond prices and better margins in the cashew business.
The Food Staples division also had a strong quarter, with segment EBITDA rising 38% y-o-y to S$118m.
The improved performance was driven by growth in grains trading volumes, better wheat milling operations in West Africa and reduced loses at the dairy farming operations in Uruguay.
Meanwhile, the Confectionary & Beverage segment had soft quarter as expected with EBITDA falling by 29% y-o-y. This was largely due to softer performance from the cocoa supply chain business as most of the cocoa origination volumes are now used for Olam’s in-house processing business.
Meanwhile, cocoa processing margins compressed from the high levels achieved last year.
EBITDA for the Industrial Raw Materials segment was down marginally by 5% y-o-y due to sluggish demand for wood products in India.

Gearing as measured by net debt (excluding readily marketable inventories)/equity was stable at 99.4% (99.7% in 4Q16 and 99.9% in 1Q16).
Olam remains in a strong liquidity position, with S$7.8bn of unutilised bank lines, readily marketable inventories of S$5.8bn and cash of S$2.6bn. This is sufficient to cover its short term debt of c. S$5.6bn.

Olam announced in 1Q17 that plans to redeem its relatively expensive 7% perpetual securities on 1 September 2017. After incorporating the buyback of these securities, we raised our FY17-18F core profit by 2-4%.
On the back of higher profits, we also raised our TP to S$2.15 from S$2.12. Our TP is a blend of our PE valuation of S$2.16 and our DCF valuation of S$2.15 Our PE valuation remains pegged to Olam’s average PE multiple which now stands at c.16.3x.

With limited upside to our revised TP of S$2.15, we maintain our HOLD recommendation.

Mervin SONG CFA DBS Vickers | http://www.dbsvickers.com/ 2017-05-16

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 2.15 Up 2.120