Comments from Olam’s management at its recent Q3-2016 earnings teleconference acutely highlight the major trends in commodities in key francophone and West African markets and, in our view, emphasise Olam’s position as the bellwether for developments in agricultural and consumer goods in the region.
A strategic cluster
Strategically, Olam considers Africa as one of its five core clusters, according to chief executive Sunny Verghese. This means the region is treated as a “vertical” with investments segmented along four themes. These leverage Africa’s natural competitive advantage in the production of commodities including cocoa, coffee, cotton and edible nuts as well as its growing consumption of grains.
Franctrade.com strongly agrees with the company’s constructive view on the region’s protein deficit although open grazing and the stunted development of commercial feedlots will challenge the feed business, particularly in francophone Africa.
Olam has therefore heavily invested in cocoa through the acquisition of ADM’s global cocoa business for USD 1.2bn, which also makes the company the third largest cocoa processor behind Barry Callebaut and Cargill. Olam also purchased BUA’s wheat and pasta manufacturing capacity in Nigeria for USD 275mn. Both investments tap into what we believe are value trades and which we expect will continue to garner momentum in the region.
Downside risks for cocoa prices
But specifically, on cocoa prices, while we agree with the view from Olam that improved weather on the 2016/17 crop will result in a better harvest relative to last season’s, Olam’s expectations for cocoa prices to remain elevated in the near term may be overly optimistic. Investors may note that lower prices on the futures market may in fact undermine the value of Olam’s cocoa inventories as this is marked to market (see franctrade’s outlook on cocoa prices).
Olam also maintains a watchful eye over the region’s potential in the fast-moving consumer goods sector given that “consumers are now moving and migrating to low unit priced packaged food brands”. While we are similarly optimistic on this trend, margins in this business may be pressured by cheaper alternatives, even from local competitors.
Gabon could play key role in region’s logistics
Olam’s port investment in a bulk port and a general cargo port in Gabon – it is expected that the latter will be commissioned by June 2017 – is opportunistic and seeks to address some of the infrastructure deficits in the region. And given ongoing socio-political challenges in the north of Cameroon, this may challenge the port of Douala as the main service station for landlocked countries in the region, including Chad and the Central African Republic.
Olam’s share price is currently trading at SGD 1.955, up around 4% year on year.