Maintain BUY with a S$2.98 target price, derived from a 3-stage DCF valuation model. Olam’s FY12 PE of 13.7x is also lower than its historical 18x average, which reflects its attractiveness.
Steady-state output by FY2025. Planting is expected to commence by FY2013 and be completed by FY2019. 1.5k hectares will be planted in FY13, 2.5k hectares in FY14 and the balance through FY19. As it takes about 63 months from planting to output, Olam sees steady-state output by
2025. Average yield of between 2.0 and 2.2 tonnes per hectare is to be expected. A processing unit with a daily capacity of 225 tonnes of rubber cup lumps forms part of the investment. At full maturity, the project will generate annual volumes of 62k tonnes of dry rubber. These rubber products will be exported to the tyre and general rubber goods industries worldwide.
Olam sees Gabon as one of the most competitive locations for rubber plantations given the availability of land, suitable soil and agro-climatic conditions and RoG support and incentives.
The project will be financed through a debt/equity ratio of 1.5:1. Olam’s equity investment is therefore US$59m, with the debt portion to be project financed. Equity IRR of 23% and ROE of 94% can be expected, according to Olam.
Olam management is positive on the JV. Olam sees wider margin in the rubber upstream business. The involvement of the RoG government is an advantage for the initiative. A 15-year tax holiday will be given (starting from the time the trees start yielding).
In arriving at the equity IRR of 23% and ROE of 94%, Olam has assumed rubber ASP which is 20% lower than the current transacted price.
Based on Phase I’s progress, the JV plans to develop an additional 22k hectares in Phase II, taking the total plantings to 50k hectares.
Price Target : S$ 2.75
Project summary
1. Phase I of project - 28k ha of rubber
2. Phase II - 22k ha of rubber taking total plantings to 50k ha
3. Total investment of c.US$183m for Phase I over the next seven years. The project is to be financed on 1.5:1 debt/equity ratio basis. Olam's equity share is US$59m.
4. 1,500 ha to be planted from FY13 before ramping up to achieve the 28k ha target. New plantings will be completed in FY19.
5. Initial land concession of 30 years with option to renew at the end of concession period.
6. Cost of production is estimated at US$1,200/MT and new planting cost of US$6,500/ha.
7. At full maturity, the project is expected to produce 62k MT of rubber, generating EBITDA of US$155-160m.
8. The project is expected to generate equity IRR of 23% and ROE of 94% based on a long-term rubber price of US$3,000/MT
Natural rubber is an attractive industry
The following are reasons supporting Olam’s expansion into the natural rubber industry
1. Rubber demand is expected to grow at 3.3% pa over the next decade on the back of growing tyre consumption from emerging countries. We estimate natural rubber demand to grow at a slightly faster rate of 3.7% p.a.
2. Olam believes that yield improvement in the rubber industry will not be sufficient to meet increasing demand over the coming decade, creating a potential shortfall in supply. Olam estimates an additional 1m ha (c.10% of world planted area) needs to be planted over next 5 years. We project supply shortage from 2019 onwards when Olam’s rubber estates come into full production. Detailed below are our natural rubber demand, supply and price forecasts.
Why Gabon/West Africa Olam is attracted to Gabon/West Africa region for the following reasons.
1. West African rubber yields of over 2.0 MT/ha p.a. exceed yields available in Asia.
2. Gabon/West Africa region is relatively more cost competitive with lower cost inflation than in Asia.
3. Olam has a 15-year tax holiday from the Gabon government.
4. Gabon offers contiguous land parcels suitable for largescale rubber estates.
5. The project allows Olam to leverage its existing investment in SIFCA, which is the largest owner of rubber plantations in Cote D'Ivoire, Ghana and Nigeria.
Potential Upside of S$0.09 per share
Based on our 30-year DCF model we estimate potential upside of S$0.09 per share from Phase I of the project. We have chosen a 30-year time horizon as rubber trees can produce latex over 20-25 years and this is consistent with initial 30-year land concession from the Gabon government.
CITI
Greenfield investment into rubber - Olam has announced a 80%-20% venture between Olam and Republic of Gabon’s government to set up 28,000 ha of rubber plantations (i.e. US$5200/ha). Phase 1 is expected to cost US$183m, with a debt/equity ratio of 1.5:1. Olam expects its equity investment to be US$59m and it would finance this via project finance debt. An additional 22,000 ha is being considered under Phase 2. In contrast, GMG Global Limited, a Singapore listed subsidiary of Sinochem Interational has ~42,000 ha of rubber plantation in Cameroon/Ivory Coast and another 45,000 ha in greenfield projects in Cameroon.
Long gestation – Rubber is a long-gestation investment, with trees taking up to seven years to mature. Plantings will start 2012 and it will take up to 2019 to complete plantings under Phase 1. Thus, this will not be a contributor to Olam’s target to double net margins to beyond 4% by 2016. Investors also typically perceive palm as a superior investment to rubber given the former’s shorter investment cycle and, thus, rubber has in past years lost areas under cultivation to palm. Olam has some prior exposure to rubber via its 50%-50% JV Nauvu Investments (with Wilmar International) that in turn owns a 25% stake in SIFCA (subsidiaries with rubber plantations in Nigeria, Ivory Coast & Ghana).
Olam is already a major investor in Gabon – It already has several large projects there, the largest being its 62.9% stake in a US$1.3b ammonia-urea fertilizer complex. Olam also has a 70% stake in a 50,000 ha palm cultivation project (US$236m) and a 60% stake in a Special Economic Zone for timber processing (US$20m). While this has been a rare instance where Olam is investing in upstream assets without having a significant presence in supply chain/processing of rubber, it is capitalizing on its close relationship with Gabon’s government to expand there. Olam will be expanding its exposure to rubber further with considerations in brownfield investments, supply chain and trading in rubber.
Scaling up on upstream investments – Olam has been busy scaling up on selected upstream investments in segments where it has identified areas where there is global cost competitiveness —dairy, palm, almonds, fertilizers and now rubber. Execution on some of these larger projects (especially its US$1.3b fertilizer project in Gabon) is key to the long-term return drivers for the company.
Well-positioned balance sheet - Aided by the ~S$740m in fresh funds raised in June 2011, Olam’s gearing levels are the lowest in five years, with adjusted net gearing at 0.42x 1H12. This is favorable vs 0.7x in adjusted net gearing at end FY08, giving it room to fund capex for growth projects and acquisitions.
Valuation
Our target price on the stock is S$3.10, which implies a FY12 PER of 22x. We expect Olam to sustain a PER of 22x. Our valuation is also consistent with the valuation obtained from utilizing a Gordon Growth valuation framework which values Olam at a price/book multiple of 2.9x using a long-term growth assumption of 4.0%, sustainable ROE of 22.0% and cost of equity of 10.2%.
Risks
Downside risks that could prevent the stock from achieving our price target include
1) a sharp decline in credit markets or other factors that could constrict trade volumes
2) its inability to refinance debt as it matures
3) poor execution, which leads to lower-thanexpected returns on its investments in plantation assets and midstream processing assets.
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