I ran into Olam’s CEO Sunny Verghese at the Cricket World Cup final in Melbourne in March 2015. Meeting an acquaintance in a stadium with 90,000 people can be a surprise. It was a stroke of luck in this case.
Verghese was courteous and cheery. We discussed the state of the match. His humility belied his rock-like determination.
We spoke about the importance of timing in cricket. New Zealand was playing Australia and had chosen to bat first in the hope that the pitch would crumble. In cricket and in business, timing is crucial.
Verghese seems to have taken this adage to heart. His move to spin off Olam Agri is opportune. This week, Olam Group announced plans to list its agricultural business (Olam Agri) in Singapore and Saudi Arabia.
The lPO plans come on the heels of a US$1.24 billion ($1.65 billion) investment by Saudi Agricultural and Livestock Investment Co (Salic). Salic is a wing of the Public Investment Fund, Saudi Arabia’s sovereign wealth fund. The deal values Olam Agri at US$3.5 billion.
Commodity traders like Olam are like DHL (listed as Deutsche Post DHL Group) and FedEx. They act as middlemen who deliver commodities like rice and wheat.
Olam Agri sources rice from ordinary farmers toiling in Asia’s rice fields. In Africa, it operates rubber plantations with an area larger than Singapore. Its customers include blue-chip consumer companies: Nestle, Unilever, Hershey and Proctor & Gamble. Olam touts itself as the brand behind the brands. One fourth of the world’s cocoa goes through Olam.
Apart from being a supplier, Olam has fixed assets. It is West Africa’s largest wheat miller, and it operates one of Ukraine’s largest grain elevators. Olam itself has been a terrific investment. Its share price is up 1.5 times since its listing in 2005. If one includes the dividends, this is return of 3.4 times. That works out to an annualised return of 8.7% making it one of the outperformers on the Singapore Exchange (SGX).
These figures mask Olam’s correlation with the food prices cycle. Though Olam says that its operating earnings are independent of food prices, the market does not think so. There is a 77% correlation coefficient between the GSCI Agri Index and Olam.
See also: Did Munger miss a trick by avoiding silver?
Olam’s return on invested capital (ROIC) has been 20% below its cost of capital since 2005. Olam operates in the frontier markets of Africa, Asia and Latin America. These countries have a double-digit cost of capital.
At first glance, the spinoff seems strange A spinoff of a business division is supposed to enhance value. Olam’s EV/Ebitda FY2022 of 10x is at a premium to the giant food traders like Bunge and ADM.
However, there is more than meets the eye. Olam could extract synergies through Salic. Salic’s investment is part of Saudi’s plans to diversify its economy beyond oil. Salic has made an estimated US$3 billion of investments in rice production in India, mutton processing in Australia, and milk manufacturing in the Gulf. Olam could vastly increase the scale of its business with its new partner.
The listing would be the first major foreign IPO in Saudi Arabia. It would provide Olam with the equity capital to expand.
Olam Agri has chosen the correct moment to expand. The world may be about to enter a new commodity supercycle. Higher incomes in emerging markets like China and India are driving consumption higher.
Food prices are skyrocketing. Supply has been disrupted by Covid and the Russia-Ukraine war. Almost every crop (maize, milk, oilseeds) is close to peak prices in nominal terms. The Economist’s food price index is approaching its all-time high since it was created in 1845.
The shift to more protein consumption accompanies prosperity. Per capita meat consumption in China was just 20 kg in 1985. It is 45 kg today and it could accelerate. It is still less than half the level in the West. If food prices continue rise, Olam Agri’s operating earnings could benefit. Ebitda may double from in five years from $753 million in FY2021. Olam Agri is valued at US$3.5 billion. We assume that a third of Olam’s debt accrues to Olam Agri. If Ebitda doubles in five years, Olam could be trading at 4x FY27 EV/Ebitda, which seems good value when the market is 5x EV/Ebitda.
As with cricket, there are glorious uncertainties in business. New Zealand lost the Cricket World Cup final in 2015, but Verghese may have a better stroke of timing.
Nirgunan Tiruchelvam is head of consumer and internet at Aletheia Capital and author of Investing in the Covid Era. He does not hold any position in the stocks mentioned in this column
