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Olam: Share price up on buy backs.

Wednesday, June 13, 2012

I have always thought Olam's gearing level quite scary. Then again, it is the same with Noble and Wilmar although not as highly geared as Olam. I was told that their business models are such that high gearing level is nothing to worry about. Indeed, Mr. Market seemed to think so as their share prices were sky high once upon a time.

Gearing is a double edged sword and if a business is able to magnify its returns through gearing, then, higher gearing would intensify the returns many times over. However, in down times, things could turn really ugly. Then again, in the current environment of very low interest rates, borrowers are shouldering much lighter burdens.

When Olam announced that they are buying back shares from the market, my immediate reaction was a positive one. Hey, the management are confident in their own business and are walking the talk. However, when we remember that it still has plenty of debt in its books, it doesn't seem to make much sense anymore.

Kim Eng has this to say:
Share price jumps on buyback mandate. Olam’s share price has jumped 11% since the company announced last Friday that it has commenced a share buyback programme. While such a move is usually a positive sign, the circumstances for Olam seem rather unusual. Fundamentals-wise, other than to deter the short sellers, we do not think it is necessarily an enhancive step for shareholders. Borrowing money to purchase shares. The case for a share buyback is stronger for companies with piles of idle cash coupled with strong operating cash flows. Olam, however, is considered highly leveraged with net gearing of 189% and adjusted net gearing of 42% as at FY6/12. Since listing in 2004, its operating cash flow has been positive only in 2006 and 2009 as funds were needed for expansionary working capital.

Kim Eng has a SELL recommendation on Olam with a TP of $1.43.


FoodieFC said...

Hi AK71

same sentimental. Their gearing is the highest! When you are in debt, and you borrow more to buy, it is a big big risk.

I have something to ask. Does the stock price affects the cash flow of a coy like Olam? Why is there a need to borrow to keep the stock price up?

AK71 said...

Hi FoodieFC,

Stock price does not affect a company's cash flow.

As for why is there a need to do share buy back to prop up its stock price, we could hazard a few guesses but only the company's management would know the exact reason(s) why. ;p

Zi Rong said...

I didn't know Olam was borrowing money to buy back shares. I thought they were using their cash for the shares buyback.

I can't really think of anything positive that the share buyback using borrowed money will bring to shareholders. I could understand if Olam gives out high dividends, and the share buyback will increase DPS. But I think the dividend yield is only 1-2%.

Perhaps the management views the current share price as significantly undervalued, and thinks that the potential growth in stock price will exceed the cost of the borrwed capital. No idea...

AK71 said...

Hi Zi Rong,

It probably did not borrow money to buy back its shares per se. Olam had raised funds by issuing bonds. Those funds did not come cheap either. Its S$350m perpetual bond issued in February 2012 yields 7% per annum.

One would think that funds raised would be put to productive use instead of propping up its share price...

FoodieFC said...

I am also wary that they are doing lots of M&A. Not that it is bad. But integration takes a long time and huge effort before the desired synergy come into play. Plus not all M&A are successful. If Olam is not careful, they might be in deep trouble.

Its price and Noble has been going up. But somehow. Wilmar is still going down

AK71 said...

Hi FoodieFC,

Indeed, there is always execution risk. Only time will tell.

As for Wilmar's share price, technically, it is oversold and it would take only a bit of good news to see an unwinding of short positions. Of course, whether there would be any good news is a good question. Haha.. I am patient. ;)

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