Should Olam just stick to Russian dairy?

Its plans to invest heavily in grain cultivation comes with risks and no major advantages, warns Daiwa.

Olam's profitability in this grain foray will hinge on farmland fertility and yields. In contrast, its partnership with RUSMOLCO to develop a massive dairy operation will enjoy brisk milk demand from Russian cities and large government subsidies.

What else should you know about Olam's new Russian investments?

Here's more from Daiwa:

Olam International (Olam) has announced (on 30 January) a partnership with the Russian Dairy Company, LCC (RUSMOLCO), for the large-scale development of dairy and grain farming in the Penza region of Russia. The initial investment by Olam is US$75m in exchange for 75% of the equity of RUSMOLCO.

Olam does not expect to inject fresh equity for subsequent expansion plans, which are to be funded through internal cash generated and debt. Over the next 4-5 years, RUSMOLCO plans to invest to expand the area under grain cultivation from the current 52,000 hectares to 106,000 hectares. In addition, four new modern dairy farms are planned, to increase the milking cow population from the current 3,600 heads to 20,000 heads.

Steady-state financial projections (from 2019 onwards) provided by the company suggest the investment would generate an IRR of 28%, with net margins of 12-15%. The acquisition is expected to be cash-flow positive from FY13 (ending June) onwards and profitable at the net profit level from FY14 onwards.

We believe this acquisition is slightly positive overall for four reasons.

1) The initial capital outlay is low and expansion should be over five years. This will allow the company to scale back/slow down expansion plans if the economics do not unfold as expected.

2) Russia has a milk-supply deficit and its milk demand is among the fastest-growing in the world.

3) The valuation paid is not significantly above RUSMOLCO’s book value.

4) The government currently provides significant incentives and subsidies to dairies and Olam has typically been adept at benefitting from such incentives.

Regarding its plans for grain cultivation, we believe Olam is unlikely to have any specific competitive advantage. Additionally, much is likely to depend on the fertility and yields that the farmland can generate.

We believe Olam’s share price is below its intrinsic value, and we reaffirm our Buy (1) rating as earnings growth should drive value accretion. The operational performance of the company’s organic trading business as well as its midstream and upstream businesses acquired have been strong.