Here's why Olam's acquisition of Brazillian asset is bitter-sweet

The sugar mill is quite small compared to competitor Noble's 17Mt crushing capacity to begin with, what'ya think?

Olam has acquired its first sugar mill in Brazil for US$129m, translating to an acquisition price of 0.8x NAV,
which we deem reasonable. At an EV/MT of US$80, this also compares favourably against recent acquisitions,
priced at US$110-128, and estimated greenfield costs of US$125-150. Olam will invest a further US$111m in capex over the next five years to improve its crushing capacity from the current 1.75Mt to 3Mt. The investment will be funded via internal accruals and borrowings.

Analysts maintain that the acquisition is value accretive but it might take time before it pays-off.

Here's what analysts have to say:

Lee Wen Ching, analyst at CIMB

We estimate insignificant earnings accrual at less than 2% of EBITDA. The investment is expected to be
earnings accretive from FY14 and is expected to deliver EBITDA margins of above 30% by steady state in FY16.
This sugar mill is small as compared to competitor Noble’s 17Mt crushing capacity, but is nevertheless in line
with Olam’s strategy of growing its sugar business and expanding upstream.

Goldman Sachs

The acquisition price works out to US$74/ton of existing capacity, or US$80/ton when fully expanded to 3mn tons. Recent transactions in Australia and Brazil have taken place at US$98-119/ton (although UAP does not include co-generation). We believe that this mill may be too small for Olam’s larger competitors in Brazil, but fits with Olam’s niche strategy.

The company estimates that at steady state (when fully expanded and rehabilitated), sugar production costs will be in the region of US$0.15-0.16/lb, compared to the industry range of US$0.15-0.23/lb, although current costs are higher. Olam expects that this acquisition will be earnings-accretive from the second year of acquisition and may deliver equity IRR of 20%.

Macquarie Equities Research:

We believe this acquisition is a strong strategic fit for Olam’s sugar business, giving it a foothold in Brazil, the largest and most competitive sugar exporter in the world.

We think Olam timed its entry into Brazilian sugar well, paying an all-in cost of US$80/MT for its mill. This compares with recent deals done at >US$110/MT and greenfield costs of US$ 125–150/MT. The deal will be marginally dilutive in FY13E and accretive from FY14E. Olam is financing the deal with existing funds.

Impact

 Olam is buying a sugar mill in Passos, Minas Gerais Brazil, with 1.7m MT crushing capacity for US$128.8 m. It plans to expand to 3.0 m tons over the next five years, which will cost another US$111.5m, bringing the total toUS$240m. Minas Gerais accounts for 10% of Brazil’s sugar cane production.

 This all in cost of ~US$80/MT compares favourably to recent deals done at >US$110/MT and greenfield costs of 125–150/MT (according to Olam).

 Ironically, the mill benefits from its relatively small size, as the bigger sugar players have been looking for bigger assets, according to Olam. Noble’s two mills purchased in December 2010, for example, combined to 8m MTcapacity.

 Still, Olam believes its mill has enough scale and benefits from being the only one within an 80 km radius. It breaks even with sugar prices at 16–18 cents in FY14 (ends June), depending on the Real/USD exchange rate (1.8–2.0). The current price is 20 cents but should rise once supplies tighten in 2H12, as we expect. We have a forecast of 25 cents for calendar 2013. Olam seems a bit more bearish, but it is still calling for the mill to be accretive in FY14. We see the deal as value-accretive on our initial calculations.