Olam (CLSA)

Olam: CLSA says Muddy Waters claims Lacks Substance. HOuse note that there is nothing unique about booking earnings when sales are made, as risk and reward are passed on to the client. Looking through the books, all cotton traders saw a massive spike in earnings during the same period. However, the problem was that when it came to payment collection, many cloth/yarn makers defaulted on payments as they were selling their end-product at a much lower price (50% lower) than the price they bought their cotton at. As a result, many firms, including Olam, had to take a hit on their books due to defaults. However, this has been worked through the system, and should not pose a problem so long as a bubble does not form again. Olam is typically 85- 90% hedged on its inventories, so commodity-price risk is not really a massive issue. Booking of biological gains. Booking of biological gains is normal and part of the IAS41 (Agriculture) requirement, and is akin to revaluing investment properties for property developers to recognise the fair value of their assets. Plantation companies are already doing this. From the perspective of analysts, house have always stripped it out of earnings, and have never considered it part of core net profit. As such, it is surprising that Block brought it up. High leverage. This is the most credible of Block’s arguments. At 190% net debt/equity, Olam is probably the most highly levered among the commodity-trading firms. To address concerns first, Olam’s headroom by banks is 4.5x net debt/equity, which still puts it comfortably below threshold. Furthermore, the bulk of that debt is used to finance rolling inventory stock, which due to the unique trades in niche agri-commodities, sees a high inventory day of 110 versus the industry average of 30-40 days. Stripping that out, its adjusted net gearing is 80-90% of the past four years, which is a much more comfortable level. Looking further into it, of its total borrowing outstanding, only 26% is based on bilateral bank relationships. The rest is on much more secured bonds (14%), mediumterm notes (21%) and bank syndications (39%). which house does not think its risky