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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.
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