Olam strategy yet to convince investors

Group fights for confidence a year after Carson Block attack

A year ago this month, Sunny Verghese, chief executive of Olam, faced the biggest crisis in the Asian agribusiness group’s 20-odd years in existence.

A man dressed in a baseball cap and jeans had visited his office in Singapore a few weeks before, purporting to represent investors with questions about Olam’s business model.

The man, Mr Verghese later claimed, was none other than Carson Block, founder of US short seller and research group Muddy Waters.

Mr Block, who does not carry business cards and has used disguises in similar situations in the past, has never confirmed or denied he was that man.

But the very public attack he subsequently launched on Olam still resonates, a year after it caused the Singapore-listed company’s shares to plunge by 20 per cent in the month following the initial broadside and sparked a sell-off in its bonds.

Investors remain unconvinced that Olam is out of the woods, and its shares are trading at 11 times estimated 2014 earnings, according to a Bloomberg consensus of analysts, less than peer Wilmar on almost 13. Olam’s shares are down 14 per cent over the past 12 months.

Under Harvard-educated Mr Verghese, Olam between 2009 and 2012 made more than 30 acquisitions as part of a strategy to secure agricultural assets and move “upstream” into ownership of commodity production, reducing reliance on trading.

Up to that point, the company, founded in 1989, had been favoured by investors as one of a new generation of fast-growing Asian commodity powerhouses, including Wilmar and Noble Group. All three are listed on the Singapore Exchange.

But Mr Block alleged that Olam, which he likened to “a degenerate gambler”, was close to financial failure because it had been on a debt-fuelled acquisition binge, from rice farms in Nigeria to almond orchards in Australia and dairy operations in Uruguay.

The turmoil calmed in December when Temasek, Singapore’s state investment agency, and four of Olam’s biggest creditor banks threw their weight behind a US$750m rights issue.

Now the coffee-to-cashews group is almost six months into implementing a revised strategy to accelerate free cash flow generation, cut gearing and simplify its business.

It no longer expects to remain free cash flow negative until 2015 – based on the gestation period of agricultural acquisitions – and has slowed or dropped some acquisitions altogether.

In a key sign of progress Olam is on track to generate positive cash flow for a full fiscal year by June 2014, the company said last week as it reported fiscal first-quarter numbers.

That is partly the result of selling and leasing back crop-growing land. Olam benefits because the rent it pays the new owners is lower than the interest cost of the debt that had to be serviced on the assets when it owned them.

The group has just concluded its second such deal, involving its almond plantations in Australia, raising A$220m (US$207m) including the sale of a cotton gin. An earlier deal involved almond orchards in California.

Olam claims to have improved its free cash flow from a negative S$707m (US$567m) in the first quarter last year to a positive S$46m this time. An almost 25 per cent reduction in capital expenditure since the previous year’s quarter has also helped.

The company reported a 5.7 per cent rise in net profit to S$45.6m in the three months to September 30. While revenue fell by 7.9 per cent year on year to S$4.3bn due to lower commodity prices, that was offset by higher margins.

Yeo Zhi Bin, analyst at CIMB, says that while Olam is making “steady strides in its focus on generating positive free cash flow”, this “comes at the cost of markedly reduced profit growth”.

Olam points to having kept its net gearing – or the maximum net debt it believes it can tolerate – to 1.9 times the equity of the company, just below a self-imposed ceiling of two times.

It also has ample funds of S$12bn to meet working capital and capital expenditure. That includes unused bank lines of S$5.7bn.

But Thilan Wickramasinghe, analyst at HSBC, says that overall gearing levels will have to fall further for any significant improvement in free cash flow to happen. “While below the self-imposed limit, it is not sufficient to improve the comfort levels of investors, in our view,” he says.

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