TWO former senior employees of UOB Kay Hian Private Limited (UOBKH) were charged on Wednesday for allegedly lying to the Monetary Authority of Singapore (MAS) in relation to reports on a then Catalist aspirant. Lan Kang Ming, 38, and Wee Toon Lee, 34, each face three charges of providing MAS with false information in October 2018 in relation to due diligence reports on an unidentified company applying to list on the Catalist board of the Singapore Exchange. MAS said in a media statement on Wednesday that it was performing an onsite inspection of UOBKH between June and August 2018, to assess the latter's controls, policies and procedures in relation to its role as an issue manager for Initial Public Offering (IPOs). During the examination, Lan and Wee were said to have provided different versions of a due diligence report relating to background checks on a company applying to be listed on the Catalist board of the Singapore Exchange. UOBKH had acted as the issue manager
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The commodity supplier responded to short-selling attacks by reducing its capital expenditure and lightening its balance sheet. That could spell slower growth, but it might also boost the company’s profitability and cash flows. Is it safe to get back into the stock?
JOAN NG, The Edge
25 November 2013
The room in which Olam International is holding its results briefing for the quarter to September is packed with analysts. Sunny Verghese, CEO of the commodity supplier, is busy fielding questions about the company’s recent performance as well as its broad operating strategy, peppering his answers with reassuring financial jargon and management consulting terms. And, the analysts are lapping it up.
There would be nothing odd about this scene except that it was almost exactly a year ago that Carson Block of Muddy Waters Research had sparked a massive sell-off in Olam’s shares by comparing the company to failed US energy trader Enron Corp, accusing it of faulty accounting and an “off-the-rails” acquisition programme. One by one, the legions of Olam supporters backed away from the stock and waited for the company to address the charges.
In the months that followed, Verghese more or less conceded that it was time for change. In April, the company said it would be “rebalancing its growth objectives with an increased focus on accelerating the generation of positive free cash flow”. It also said it would move to reduce its gearing levels, reduce the complexity of its business and help investors understand it better.
Since then, Verghese has been as good as his word. Among other things, Olam has announced the sale of its Dirranbandi cotton gin in Queensland to Cubbie Ginnery for A$20 million ($23.3 million). It has raised US$20 million ($24.9 million) through the sale of a 25% stake in its Nigerian instant noodles business to a Japanese company called Sanyo Foods. In March, Olam had sold its Basmati rice mill in India for US$14.5 million.
Earlier this year, Olam held an investor day for its spices and vegetable ingredients businesses, and another for its grains and packaged foods businesses. Heads of those units, who had very granular details on ground operations, were flown in to Singapore to meet with investors and answer questions. Olam also took a group of analysts on a field visit to Nigeria and Gabon.
Verghese has also begun presenting Olam’s results in a new format: including a section for management discussion and analysis, and placing more emphasis on earnings before interest, taxes, depreciation and amortisation (Ebitda). Meanwhile, the company is delivering financial numbers that are exactly what the market has been hoping to see. For 1QFY2014 (the company has a June year-end), Olam reported a 7.9% decline in sales to $4.3 billion, but a 5.7% improvement in earnings. Significantly, operating cash flow was positive during the quarter. The company also generated positive free cash flow to firm (FCFF), which excludes interest expenses.
Perhaps more important than any of this, however, is that Verghese is making a virtue of necessity with the repositioning of Olam, deftly explaining to the market that the company is trading off growth for improved profitability and cash flow generation.
For instance, as part of its efforts to slim down its balance sheet, Olam has done sale-and-leaseback deals for its almond orchards in the US and Australia. The deal in Australia, announced on Nov 13, will see Olam selling both the orchard land and the almond trees, while retaining the “production economies of the entire almond harvest”. Olam will also retain its water rights.
The sale-and-leaseback of almond orchards in Australia alone will bring in A$200 million when completed, helping to lighten the company’s balance sheet significantly. On top of that, the deal will save Olam money, as the cost on the operating lease is lower than the interest on the debt associated with the asset.
Responding to criticism
Olam was not the only company to find itself in this predicament last year. When it listed in 2005, the company was merely a supply chain manager of soft commodities - buying almonds, cashews and peanuts from farmers and selling them to large companies such as Nestle and Kraft Foods Group.
Almost as soon as it hit the market, the commodity boom began to gather pace, with the Thomson Reuters/Jefferies CRB Commodity Index going into a steep ascent that didn’t really abate until 2008. Taking advantage of the trend, Olam expanded upstream and downstream through debt-fuelled acquisitions that significantly expanded its portfolio and asset base. The company’s acquisitions of upstream production assets generated the most excitement in the market, as this was where a large portion of the profits along the commodity supply chain was being generated.
Other commodity suppliers were pursuing similar expansion strategies, encouraged by the positive market reaction that greeted bold deals. For instance, Olam’s locally listed peers Noble Group and Wilmar International were also bulking up their asset base and product portfolio. On the international front, Glencore Xstrata listed in London to tap the markets for capital to grow. Yet, Verghese’s penchant for ambitious targets made Olam a particularly hot commodity play. Specifically, he promised annual earnings growth of more than 20% to achieve US$1 billion in earnings by FY2016, and laid out a string of initiatives and acquisitions that would enable Olam to get there.
Things began to unravel last year, though. Even with ultra-loose monetary policies, growth in developed countries was anaemic. And, major emerging markets such as China, India and Indonesia began grappling with inflation and runaway asset prices. Once a sure-fire play on the soaring wealth of the vast populations of these countries, the bulked-up commodity players suddenly looked too asset-heavy to stay in the air.
Olam looked particularly vulnerable. It had assembled a broad range of commodity businesses that spanned the globe and that few investors fully understood. And, its heavy debt load was becoming harder to explain as the commodity cycle began weakening. That was when Block of Muddy Waters struck, with a 133-page report dated Nov 27, 2012 in which he called a “strong sell” on the stock.
Block criticised Olam for its high gearing, aggressive capital expenditure, poor acquisition strategy and complex business model. He also noted that the company had failed to generate positive free cash flows, and suggested that Olam’s high rate of earnings growth had been generated by questionable accounting practices.
Verghese’s initial reaction was to deny everything and launch legal proceedings against Block, which ultimately went nowhere. As shares in Olam slumped amid concerns about its ability to maintain the confidence of its creditors, the company rolled out plans to sell as much as US$1.3 billion in bonds and warrants to its shareholders. Its second-largest shareholder Temasek Holdings agreed to take up its own entitlement as well as any unsubscribed entitlements of other shareholders.
“The next three-year plan is a total capex spend of $1.5 billion compared with the roughly $3.5 billion that we spent in the last three-year period. So, we are reducing our capex rate by more than 50%,” says Verghese. “We are not going to be doing any new investments that are off-strategy or off-plan.”
Does a more modest and careful pace of expansion spell a more robust stock? Is Olam on the road to recovery? Should investors get in now? How high could the stock climb? What are the risks ahead?
Market laggards
While Olam has made significant progress in slimming down its portfolio and improving its cash flow, Block hasn’t let up with his criticism of the company. He has found fault with Olam’s focus on delivering positive FCFF, which doesn’t include interest expenses. In a note earlier this year, he pointed out that Olam’s interest expense was a significant 70% of its operating cash flow for 2QFY2013. Also, Olam’s gearing level of 1.9 times is still high relative to the other blue chips listed here – regardless of what sectors they operate in.
For his part, Verghese says delivering positive FCFF is just a first step. “There are different levels of cash flow. First is operating cash flow. Last year, we were negative [on that]. This year, we are positive,” he points out. “Then, after accounting for fixed capital investments and changes in working capital, [there is FCFF].” Once this has turned positive, Olam will focus on its “free cash flow to equity [FCFE] “, Verghese adds.
In the meantime, Olam is reporting all three measures of its cash flow so that investors have a clear sense of the progress it is making. “This year, we will be operating cash flow-positive and FCFF-positive. Over time, we will become FCFE-positive – within three years,” Verghese promises.
Yet, shares in Olam might not be doing much better even if it were already achieving positive FCFE. Commodity stocks in general have performed poorly in the last couple of years. While equity markets have more or less returned to their previous peaks - and in some instances already surpassed them commodity plays have generally lagged behind.
In the local market, Olam’s closest peers Noble and Wilmar are still trading well below the all-time highs they touched in the rebound following the global financial crisis. Even pureplay commodity firms such as Golden Agri-Resources and Indofood Agri Resources are below their previous peaks. That partly reflects a general softening in commodity prices, and a broad increase in operating costs.
Is the global commodity supercycle driven by the emergence of China and India over? Will commodity stocks ever reach their pre-crisis highs? This past week, the Organisation for Economic Co-operation and Development downgraded its forecast of global growth for this year and next on “underlying fragilities” in the emerging economies.
John Calverley, head of macroeconomic research at Standard Chartered Bank, is more sanguine, though. According to him, the world is currently in an economic supercycle similar to the one experienced from 1945 to 1973 and 1817 to 1913. That’s being driven by the increasing weight of major emerging-market economies in global GDP.
In the energy sector, notably, a significant increase in supply is now weighing down on prices, according to him. In fact, he sees oil prices moving slightly lower on the back of an increase in supply.
Cautious optimism
Against such a backdrop, the challenge for Olam is to drive volume growth across its commodity business, and keep its costs as low as possible to maximise its margins. And, investors should prepare themselves for more pedestrian earnings growth.
Wei Bin, an analyst at Maybank Kim Eng, says in a report: “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.”
During the quarter, Olam’s volumes dipped 0.3% to 3.67 billion tonnes. Revenues were also lower, owing to soft commodity prices. “We expect slower volume growth [owing] to a scale-back in capex, suggesting slower earnings growth ahead. Also, its leveraged balance sheet makes it vulnerable to a spike in global interest rates,” Wei adds.
On balance, however, Wei figures it won’t pay to remain negative on the likes of Olam. He now rates Olam a “hold”, up from a “sell” before. “After recent years of [going through an] 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,” he says in the report.
Wei’s views are largely echoed by other analysts. “Olam is making steady strides in its focus on generating positive FCF in 2014. But this comes at the cost of markedly reduced profit growth,” says CIMB Research in a client note. “The challenges of balancing growth with prudence could act as a brake on the share price.”
Another report, by DBS Vickers analyst Ho Pei Hwa, notes that Olam is trading at inexpensive valuations of 11 times her estimated earnings for FY2014 and 1.1 times book value, against a decent return on equity of 11 % and her estimate of a compound annual earnings growth rate of 36% from FY2013 to FY2015. “However, we would like to monitor its earnings delivery and sustainability of cash flow improvement for another quarter or two before turning positive on the counter,” says Ho, who, like the majority of analysts covering the stock, has Olam rated a “hold”.
After spending a year making Olam’s business more appealing to the investors, Verghese’s next challenge may be to convince the market that the commodity space still offers the promise of growth.