Olam International is not a quick buck chaser: Standard Chartered

Maturing almond business is proof positive.

In a new equity research report, Standard Chartered defended Olam from accusations that it is buying earnings via M&A, acquiring poor-quality assets, creating earnings via negative goodwill and biological asset valuation, being on a perpetual cash-burn trajectory and generally spinning out of control. Standard Chartered cited Olam's investment and business development strategy surrounding its Australian almond operations as evidence that shows otherwise.

Here's the detailed analysis from Standard Chartered:

Buying earnings via M&A. With a large fixed cost base and an immature profile (average age at acquisition of roughly four years, with a first-year crop of 15,700mt compared to nearer 40,000mt at maturity, with significant operating leverage), the almond orchards can be viewed as buying operating losses rather than earnings. Indeed, it is this type of gestation period, common among agricultural assets, that masks the real benefit yet to accrue to Olam‟s P&L from its M&A activities – the exact opposite of „buying earnings‟. Rectification work to redress a short (six-month) period of sub-optimal nutrient and water application (cash conservation) adds weight to the argument that this is not a simple „buy earnings‟ strategy.

Acquiring poor-quality assets. While Olam acquired the almond orchards from Timbercorp‟s Receiver, we note (1) the assets acquired represent a significant chunk (c.45%) of Australian almond production, (2) Australian almond orchards typically generate higher yields than those in the US, and (3) in this instance, the orchards came with crucial / valuable water rights attached. This is a simple case of the right crop being in the right place with the right inputs available. We also note that the move to voluntary administration by Timbercorp was brought on by financial dynamics – a function of the global financial crisis – rather than the quality of these assets.

Creating earnings via negative goodwill. A distressed asset sale is highly likely to generate negative goodwill. Sales by receivers are generally viewed as such events…an opportunity to buy on the cheap. The Australian almond orchard transactions, according to the FY10 annual report, resulted in SGD 23.7mn of negative goodwill, or less than 10% of the consideration value. We believe viewing this as a transaction to create earnings via the generation of negative goodwill to be disturbingly biased. We note also the removal of such earnings in the presentation of adjusted earnings.

Creating earnings via biological asset valuation. Under accounting standards, biological asset revaluations are mandatory. Acquiring an immature asset will, because of the time horizon to maturity changing, result in biological asset gains (ceteris paribus). In the case of plantation assets, this move to maturity incurs relatively full costs (charged to P&L), but suboptimal harvests to spread these costs over creating an at least partially offsetting earnings drag. We estimate that just more than half the biogains of SGD 54mn in FY10 and the majority of FY11 biogains of SGD 80mn came from the Australian almond orchards. By FY12, with yields increasing, the Australian almond gains drop to half of those reported.

Perpetual cash burn. With the processing plant completed and the almond orchards moving towards full maturity, free cash flow generation (operating cash flow less capex) should shift to being a material positive, especially with inventory being grown in-house, with resulting minimal working capital cost. This shift to optimal positive cash flow has taken 5-6 years to achieve. Again, this reflects to us a management team that invests for the medium-to-long term, rather than, as some have accused, one that chases the quick buck.