Risk management key to Olam’s gain
Olam International Ltd, one of the world’s top three suppliers of rice, cocoa and coffee, posted a gain in first quarter profit, while rival Noble Group Ltd had its first loss in 14 years. Risk management was a key difference.
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Cotton unit remained profitable in face of high volatility
Bloomberg
19 November 2011
Olam International Ltd, one of the world’s top three suppliers of rice, cocoa and coffee, posted a gain in first quarter profit, while rival Noble Group Ltd had its first loss in 14 years. Risk management was a key difference.
Olam’s cotton unit remained profitable even as the price of the fibre fell 55 per cent from a March record and drought cut supplies from the US. Hong Kong-based Noble may have lost as much as US$200 million on cotton, said John Rachmat, an analyst with the Royal Bank of Scotland plc.
‘The losses are probably a one-off event, but the longer-term impact is that people will have a lot more favourable view of the way that Olam manage their risk as compared to how Noble manage theirs,’ Mr Rachmat said. ‘Investors will probably be now more willing to give a premium to Olam rather than Noble.’
A doubling of cotton prices last year was followed by a return to September 2010 levels in July, leading to ‘massive systematic default by farmers, particularly in the US’, Noble, which competes with Olam in food products, said last week when chief executive officer Ricardo Leiman also resigned. Olam reported no farmer defaults in Australia and only one in the US, which accounts for 20 per cent of its cotton business.
‘Noble’s risk management’ is in question, UOB-Kay Hian Holdings Ltd analyst Eugene Ng said in a report on Thursday, rating Noble, a commodity supplier part-owned by China’s sovereign wealth fund, a ‘sell’ and Olam a ‘buy’. ‘Olam could be viewed by the market to have managed its risks more robustly than Noble.’
Noble declined to comment on the cotton loss estimate, Stephen Brown, the group’s head of investor relations, said yesterday in an e-mail. ‘We don’t talk about the specifics around the division results,’ chief financial officer Robert van der Zalm said on Nov 9 on a conference call.
Olam, which counts Singapore’s Temasek Holdings as its second-largest shareholder, has declined 14 per cent since Nov 9, the day that Noble reported its results. Noble is down 30 per cent in the period. This leaves Olam trading at 11.3 times its trailing 12-month earnings to Noble’s 10.74. For the current fiscal year, the gap is wider with Olam trading at 13.14 times earnings to Noble’s 10.96. The multiples for both beat those of the six main Japanese trading houses led by Mitsubishi Corp.
Noble fell 4.3 per cent to S$1.12 in Singapore yesterday, the lowest since July 14, 2009. Olam declined 3.4 per cent to S$2.26, a five-week low.
China, India, the US, Pakistan and Brazil produce almost 80 per cent of the world’s cotton. The US, the largest exporter, expects to see sales volumes plunge 21 per cent, according to the US Department of Agriculture, because Texas, the country’s top growing state, had the worst drought in at least a century.
Price fluctuations tempted some parties not to honour their contracts, helping push 168 disputes to arbitration as of Oct 24, more than triple the annual average, the International Cotton Association Ltd in Liverpool, England, said last month. One trader filed 30 cases, Olam CEO Sunny Verghese said on Nov 14 in Singapore, without identifying the company.
Through sourcing in Australia and its ginning mills, Olam gained ‘significant income revenue relative to peers’, chief financial officer Krishnan Ravikumar said on Monday. While Olam faced some customer defaults and negotiations, ‘those are a small part of the total volumes we supply’, he said.
Olam aims to more than triple annual profit to US$1 billion in 2016, expanding in cotton in Ghana, urea in the Republic of Gabon and dairy farming in Latin America.
Australia will boost exports to a record 4.2 million bales in the year that began Aug 1. In the US, where Noble said that it faced most of the defaults, cotton shipments are shrinking at the fastest pace in five years, the USDA said Nov 9.
To cut risk in cotton, Noble is focusing on shortening the contract time and securing more collateral, Mr Van der Zalm said on Nov 9. He said he didn’t think entering the ginning part of the business would help Noble.
‘It’s difficult to speculate’ on whether Noble faces further losses on cotton in the current quarter, he said.
Twelve analysts in the last month cut their net income forecast for Noble by an average of 22 per cent, according to data collected by Bloomberg. Two analysts have raised their profit forecast for Olam and one cut it, taking the average down by 0.1 per cent, the data show.
Cotton futures slumped from the record as global cotton stockpiles rise for a second straight year amid weakening demand. Futures, which almost tripled in the two years through 2010, closed on Thursday at 96.48 US cents in New York, taking this year’s losses to 33 per cent.
‘The kind of volatility seen in the cotton market this year has not been seen since the US civil war, so we believe that this is a one-off event,’ Mr Leiman said on a conference call Nov. 9.
The worst is probably over for Noble, James Koh, an analyst with Kim Eng Securities, said in a report. ‘This is a short-term blip.’ Olam faced a similar situation to Noble’s US experience in the last fiscal year when Australia’s Queensland was hit by the worst flooding in 50 years, destroying cotton crops, Mr Verghese said.
To deal with the volatility this year, Olam set up direct hedges with banks as opposed to buying futures contracts on an exchange, Mr Verghese said. An over-the-counter contract does not require collateral, the need for which grows as the price of the underlying commodity rises.
Olam also renegotiated cotton contracts with buyers after prices plunged to avoid defaults and avoided linking supply to acreage as opposed to volume, Mr Verghese said.
Judging a company’s performance by the market it operates in is tough since the commodity suppliers do not disclose their trading volumes, Mr Rachmat said.
‘As an investor you cannot do a fundamental analysis,’ Mr Rachmat said. ‘So you have to rely on more general principles. And if you find risk management to be of a somewhat doubtful quality, you draw your conclusion from that.’