Expect Olam to outperform its hard commodity peers

Pushing upstream into rice farming and milling. Olam International Limited recently announced that it will be investing US$49.2m to set up a 6k hectare (ha) greenfield, fully integrated, mechanized and irrigated paddy farming and rice milling facility in Nigeria. Management intends to carry out the farming operations in a phased manner between the last quarter of FY12 and FY16. Olam estimates that the peak yield could hit 10 metric tonnes (MT) per ha (over two annual crop cycles) and provide 60k MT of paddy annually to the rice processing facility; this would in turn be converted into 36k MT of milled rice to be distributed through its existing network of distributors and dealers across Nigeria. Olam intends to fund the move via a combination of internal accruals and borrowings.

Also expanding its wheat milling facility in Nigeria. Separately, Olam also announced that it will be investing US$50m to expand its wheat milling capacity at Crown Flour Mills (CFM) in Nigeria, which already ranked among the three biggest wheat millers in the country. The investment will lead to (a) the addition of a semolina mill and a flour mill in Lagos, each of 250 MT per day (TPD); and (b) a 250 TPD flour mill in Warri, taking the total installed capacity from 1,630 TPD to 2380 TPD; and (c) increased silo storage space to accommodate an additional 18k MT of wheat storage across Lagos and Warri. Olam expects the construction and commissioning of the investment - which it will fund using internal accruals - to take 17 months.

Moves will focus on more basic food space. We view the latest moves positively as it would allow Olam to move further upstream into the more basic food commodities space, which should continue to remain fairly resilience even in a global economic slump. However, we note that these investments will take some time before they can contribute meaningfully to the bottom line; and may even be a mild drag on operations due to the initial start-up costs. But in the grand scheme of things, we do not expect them to have much impact either way for now. Hence, we intend to leave our estimates for both FY12 and FY13 unchanged for now.

Maintain HOLD with lower S$2.05. But in line with the weaker overall outlook, we lower our valuation peg from 18x to 14x (or one standard deviation below its 5-year average); and this drops our fair value from S$2.63 to S$2.05. Maintain HOLD as we expect Olam to outperform its hard commodity peers despite weaker economic prospects. We would be buyers at S$1.85 or lower.