Olam’s profit up 48% in 3Q11

Olam has a strong track record. From FY07 till FY10, Olam recorded a net contribution CAGR of 37%, which was driven by both organic and inorganic growth. The recent 3QFY11 core net profit was also up 48% YoY, due to strong volumes and higher net contribution per ton, which reinforces our view that Olam continues to record robust growth momentum. Our 3-stage DCF-derived price target of S$3.70 takes into account a strong average growth rate of 29% pa till 2016, a gradual decline in growth rate till 2021, and thereafter terminal growth rate of 4%. Our target price works out to 19x FY12 P/E, which is the same as its 4-year historical of 19x. BUY recommendation maintained.

A key contributor to future earnings is the urea manufacturing project in Gabon. Olam will have a 62.9% stake in this 1.3m tonnes pa urea manufacturing plant in Gabon, which will be operational in mid-2014. With a 25-year competitive fixed-price natural gas supply agreement with the Republic of Gabon, margins are expected to be wide. Olam has forecasted steady state EBITDA of US$325m pa from this urea project. This accounts for one-third of our forecast Olam FY14 EBITDA. Removing the earnings to the minority shareholders, the urea plant will still contribute ~18% of our forecast Olam FY14 net profit.

More potential for acquisitions following equity fund raising. Olam raised a total of S$740m through the issue of new shares and rights offering in Jun and Jul 2011. The issue of the additional 286m shares accounts for 11.8% of Olam’s enlarged capital. Without factoring in more acquisitions, we estimate Olam’s net gearing will fall to 1.49x at end FY12 from FY10’s 1.90x.
However,we believe Olam will use the funds to generate growth via acquisitions, which will give an additional boost to future earnings.

Other key pointers
Urea manufacturing facility a key boost to future earnings. Olam is positive on the prospects for its upcoming 1.3m tonnes per annum port-based urea manufacturing plant in Gabon.

Low production cost. Natural gas is the largest cost component for urea manufacturing. Olam has secured a 25-year competitive fixed-price natural gas supply agreement with the Republic of Gabon at an attractive rate. RoG has reserves of gas but the quantum is not large enough to justify laying a line to export the gas – hence RoG wants to sell it internally.

•Tax incentives. There is a 10-year tax holiday for the Gabon project, and Olam will enjoy lower tax rates for the subsequent 10 years.

•Tata Chemicals participation will lower operations risk. Chemicals Ltd is a market leader in the urea and phosphatic fertilizer segment and operates one of the world’s most energy efficient urea facilities of 1.25m tonnes per annum in Uttar Pradesh, India. TCL, which has taken a 25.1% stake in the Gabon urea project, will be responsible for project management, commissioning of the plant and operation & maintenance of plant for the first three years post commercial production. With an experienced player of TCL in the project, we believe the operational risks are greatly lowered.

• TCL committed to off-take 25% of output into Indian markets, subject to the de-regulation of urea imports into India. This will reduce sales risk for the Gabon project.

• TCL’s subsequent investment in urea plant was at a much higher pricing than Olam’ earlier commitment. In Nov 2010, the urea project was set up through a JV between Olam with 80% and RoG with 20% at the estimated cost of US$1.3b, of which 65% will be via debt financing and the balance 35% or US$455m via equity investment. In Apr 2011, TCL invested US$290m to acquire a 25.1% stake, which translates to a project equity valuation of US$1.16b, which is a 154% premium over the initial US$455m equity. This suggests that TCL places a greater value on the project than the initial commitment by Olam.