In a de-risking mode. After recent years of acquisition spree, management has shifted its focus towards de-risking the group’s balance sheet. This is a necessary and sensible move to regain investor confidence. Management is hopeful of turning the group into a free cash flow positive territory by FY6/14. We think it may be too optimistic and believe this could be delayed to FY6/15.

Worst is behind us but concerns remain. While operationally, the worst appears to be behind us, the group’s fortunes will continue to be held hostage by volume growth and commodity prices volatility. We expect slower volume growth (7.5% CAGR for FY6/14-16F) due to a scale-back in capex (guidance for FY6/14-16 cut by SGD1b), suggesting slower earnings growth ahead. Also, its leveraged balance sheet makes it vulnerable to a spike in global interest rates.

How vulnerable is Olam to a rise in interest rate? In our view, Olam’s highly leveraged balance sheet is unlikely to improve significantly given the large working capital required to support its full value chain operations that starts with upstream plantation to downstream consumer products. Based on our estimates, every 1ppt increase in cost of debt would lead to an 18.5% decline in forward earnings. This is significantly higher than that of Noble (9.8%) and Wilmar (3.2%).

Upgrade to HOLD given limited share price downside risk. At 0.9x FY6/14 BVPS – more than one standard deviation below its trailing P/BV average since Jan 2008 – share price downside is limited, in our view. We are encouraged by management’s strategic move to de-risk the group’s balance sheet though it may take time to bear results. With the worst now behind us, we upgrade Olam to HOLD with SGD1.57 TP, based on 12x FY14 EPS, a 25% discount to its trailing P/E average since Jan 2008. For exposure to commodity traders, our preferred pick is Wilmar which we rate at BUY with SGD4.30 TP, based on 14x FY14 EPS.  

Source: Maybank Kim Eng Research - 19 Nov 2013