Olam International - DBS Research 2018-03-01: Positives Priced In For Now

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OLAM INTERNATIONAL LIMITED O32.SI

Olam International - Positives Priced In For Now

• Olam International's FY17 core profit up 23% y-o-y - above expectations.
• Better than expected performance from edible nuts.
• Achieves target of positive free cashflow to firm and equity.
• Rewards shareholders with higher FY17 DPS of 7.5 Scts, up from 6.0 Scts in FY16.

Limited upside for now. 

• We maintain our HOLD call on Olam International (Olam) with a revised Target Price of S$2.31. 
• Olam appears to have successfully integrated the US$1.2bn acquisition of ADM Cocoa, and has achieved its target of positive free cash flow to firm/equity by end FY17. However, with limited upside to our Target Price, 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 Target Price is unlikely at this stage.

Where we differ – Sell calls unwarranted. 

• Consensus has SELL ratings on Olam, which we believe is unwarranted. While Olam still generates suboptimal returns, we believe the company should deliver healthy 8% EPS growth in 2018, given continued maturity of the upstream assets, growth of in its Edible Nuts and recovery at its Confectionary & Beverage division. 
• In addition, Olam has also delivered on its target of delivering positive free cashflows.

Significant medium-term upside. 

• 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$3.9bn worth of immature assets which on maturity, could generate an additional c.S$0.3bn-0.4bn in EBITDA. 
• All these factors may allow Olam’s share price to re-rate closer to S$2.75 in the medium term, price levels at which Mitsubishi acquired its most recent equity interest in Olam.

Valuation

• On the back of better than expected FY17, we raised our Target Price to S$2.31 from S$2.15. 
• Our Target Price is a blend of our PE valuation of S$2.41 and our DCF valuation of S$2.20.

Key Risks to Our View

• The key risk to our neutral stance is a faster than expected delivery of earnings from Olam’s gestating/immature assets and deployment of over c.S$600m from the conversion of outstanding equity warrants.

WHAT’S NEW - Delivers on free cash flow targets 

FY17 results above expectations

• 4Q17 core profit (excluding exceptional, biological losses and after perpetual dividends) jumped 55% y-o-y to S$109.9m taking FY17 core profit to S$446.8m (+23%). This was above expectations largely due to higher contribution from the edible nuts segment as we had under estimated the margins for the business.
• Underpinning the robust 4Q17 and FY17 profitability was the 85% and 56% increase in volumes on account of greater oil seeds and rice trading despite the difficulties experienced in the coffee business. 
• Pleasingly, Olam also delivered on its stated target of generating positive cash flows. For FY17, free cash flow to firm (FCFF) and free cash flow to equity (FCFE) stood at of S$1.5bn and S$1.0bn respectively. The positive cash flows were achieved through a reduction in capex, working capital optimisation and lower prices for certain commodities.
• On the back of higher earnings, Olam also lifted its final dividend to 4.0 Scts, taking dividends for the whole of FY17 to 7.5 Scts up from 6.0 Scts in FY16.

Strong contribution from Edible Nuts and Food Staples

• The Edible Nuts segment had a strong end to the year with 4Q17 EBITDA rising 13% y-o-y to S$99.1m. This translated to FY17 EBITDA of S$438.4m which was higher than our original S$351m forecast largely due to higher than expected margins (EBITDA/MT of S$299 versus our forecast of S$254m). The robust esults were also attributed to strong FY17 volume growth of 7.8% which came mainly from the cashew, almonds, sesame and spices businesses.
• The healthy FY17 performance was also attributed to a 9% y-o-y jump in EBITDA from the Foods Staples and Packaged Foods segment. The segment benefited from a significant interest in trading volumes from grains which resulted in FY17 volumes jumping 78% y-o-y. The division also posted a recovery in dairy and packaged food business post the stabilisation of the Nigerian Naira.
• The industrial raw materials division had an excellent FY17, with EBITDA jumping 46% y-o-y. The significant improvement was attributed to the commission of new ports and the partial sale of the port concession rights in Gabon in 4Q17. The core cotton business also did well, which contributed to the segment’s FY17 volume jumping 39% y-o-y.
• However, the confectionery & beverage ingredients segment had a weak year with EBITDA down 20% y-o-y to S$328m. Despite volumes increasing by 22% y-o-y, margins were under pressure due to tougher market conditions in the coffee business. This was partially offset by better performance of the cocoa business as the processing business benefited from firm combined cocoa ratios.

Fall in gearing due to conversion of warrants

• On the back of conversion of outstanding warrants into shares worth c.S$585m, gearing as measured by net debt (excluding readily marketable inventories)/equity fell to 76.5% from 99.7% at end 4Q16. Post balance date, another 50m warrants were converted into equity raising c.S$72m. Given the stronger balance sheet, there is potential for Olam to pursue acquisitions. 
• Olam also remains in a strong liquidity position, with S$8.5bn of unutilised bank lines, readily marketable inventories of S$4.5bn and cash of S$2.0bn. This is sufficient to cover its short-term debt of c. S$4.7bn.

Returns still sub-optimal

• Owing primarily to Olam still having a large portion of gestating or partly contributing assets worth S$0.3bn and S$3.6bn respectively, Olam’s returns as measured by EBITDA/average invested capita (IC)l is still sub-optimal.
• For example, Olam’s gestating and partly contributing assets are only delivering EBITDA/average IC of -0.5% and 2.8% compared to its target of between 15-18%. Likewise, the partially contributing mid/downstream assets are generating EBITDA/average IC of 9.5% compared to target of between 13-16%. Even its fully contribution assets have room to improve with the upstream, supply chain and mid/downstream assets achieving an EBITDA/Average IC of 7.8%, 7.3% and 11.1% compared to target of 15-18%, 10-13% and 13-16%.
• As Olam sweats its more mature assets and operating conditions normalise in the coffee market as well as its immature assets such as its rubber and palm plantations reach full maturity, we believe there remains significant upside to Olam’s earnings going forward.

Positive momentum to flow into 2018

• Going forward, we expect the positive momentum from 2017 to flow into 2018, as Olam benefits from the normalisation of the coffee market as supply increases, further growth in volumes across its different business segments. 
• In addition, we expect its initiatives to improve its previously underperforming dairy and tomato businesses to bear fruit.

Raising earnings estimates

• On the back of stronger than expected FY17 earnings, we raised our EBITDA/MT assumptions for the edible nuts segment. In addition, due to the strong volume growth achieved in FY17, we now project volume growth of 3- 5% for FY18-19 versus 2-3% previously. This leads us to raise our FY18-19 core profit by 6%.
• Consequently, we raised our Target Price to S$2.31 from S$2.15. Our Target Price is a blend of our PE valuation of S$2.41 (previously S$2.16 and pegged to average PE multiple of 16.1x) and our DCF valuation of S$2.20 (previously S$2.15).

Maintain HOLD with revised Target Price of S$2.31

• While we remain positive on the long-term outlook for Olam, with limited upside to our revised Target Price of S$2.31, we maintain our HOLD recommendation.

Mervin SONG CFA DBS Vickers | http://www.dbsvickers.com/ 2018-03-01

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 2.31 Up 2.150