Muddy Waters target Olam. The US-based hedge fund/ research co, has targeted Olam this time round with several allegations. Without the benefit of the full report, we think the broad claims so far are nothing really new and agree that they are unsubstantiated. There have already been several other similar incidents over the past years. In our opinion, the broader question investors should be asking is what kind of valuation to attach to a business which is inherently complex.

"Books profits on transactions before it’s clear how deals will work out over time". It’s unclear to us or the company what the first of the 3 broad accusations so far means. In our view, this could refer to commodity supply transactions which are recorded before delivery of the actual cargos as in the case of cotton where a default by growers resulted in eventual losses. Such forward purchase/ sale agreements are typical for commodity traders and counterparty-risk remains the most apparent risk factor.

"Heavily-indebted". Olam currently has a net-debt/ equity of 2x and adjusted net-debt/ equity (counting liquid inventory as cash) of 0.57x. This has been an ongoing feature for many years and management reiterated that its credit bankers are comfortable with the company going up to 4.5x net-debt/equity.

"Aggressive reporting of biological gains" Recognition of biological gains is a standard accounting practice by plantation companies. The difference here is that Olam makes a distinction between “operational” vs “non-operational” gains. Management classifies most of its gains as the former which is typically an improvement in production yields etc following expenditure. The other issue here perhaps is that this item forms an exceptionally big portion (25% in FY12) of pre-tax profit.

Maintain HOLD. Olam has businesses across 65 countries, 16 product platforms, along different parts of the value chain with differing business practices. This provides a business model with huge scalability, but at the same time complexity. Without further substantiation to the Muddy Waters claims, we maintain our HOLD recommendation and our TP of SGD1.75, based on 1.2x P/B. We estimate book value stands at SGD1.45/ share while NTA is SGD1.15.

Source: Maybank Kim Eng Research - 21 Nov 2012