Bloomberg News

Olam Wresting Rival Noble’s Stock Premium on Risk Management

November 20, 2011

(Updates share price in eighth paragraph.)

Nov. 18 (Bloomberg) -- Olam International Ltd., one of the world’s top three suppliers of rice, cocoa and coffee, posted a gain in first quarter profit, while rival Noble Group Ltd. had its first loss in 14 years. Risk management was a key difference.

Olam’s cotton unit remained profitable even as the price of the fiber fell 55 percent from a March record and drought cut supplies from the U.S. Hong Kong-based Noble may have lost as much as $200 million on cotton, said John Rachmat, an analyst with the Royal Bank of Scotland Plc.

“The losses are probably a one-off event, but the longer- term impact is that people will have a lot more favorable view of the way that Olam manage their risk as compared to how Noble manage theirs,” Rachmat said. “Investors will probably be now more willing to give a premium to Olam rather than Noble.”

A doubling of cotton prices last year was followed by a return to September 2010 levels in July, leading to “massive systematic default by farmers, particularly in the U.S.,” Noble, which competes with Olam in food products, said last week when Chief Executive Officer Ricardo Leiman also resigned. Olam reported no farmer defaults in Australia and only one in the U.S., which accounts for 20 percent of its cotton business.

“Noble’s risk management” is in question, UOB-Kay Hian Holdings Ltd. analyst Eugene Ng said in a report yesterday, rating Noble, a commodity supplier part-owned by China’s sovereign wealth fund, a “sell” and Olam a “buy.” “Olam could be viewed by the market to have managed its risks more robustly than Noble.”

Trading Multiples

Noble declined to comment on the cotton loss estimate, Stephen Brown, the group’s head of investor relations, said today in an e-mail. “We don’t talk about the specifics around the division results,” Chief Financial Officer Robert van der Zalm said Nov. 9 on a conference call.

Olam, which counts Singapore’s Temasek Holdings Pte as its second-largest shareholder, has declined 14 percent since Nov. 9, the day Noble reported its results. Noble is down 30 percent in the period. This leaves Olam trading at 11.3 times its trailing 12-month earnings to Noble’s 10.74. For the current fiscal year, the gap is wider with Olam trading at 13.14 times earnings to Noble’s 10.96. The multiples for both beat those of the six main Japanese trading houses led by Mitsubishi Corp.

Noble fell 4.3 percent to S$1.12 in Singapore today, the lowest since July 14, 2009. Olam declined 3.4 percent to S$2.26, a five-week low. The Straits Times benchmark index dropped 1.7 percent.

Worst Drought

China, India, the U.S., Pakistan and Brazil produce almost 80 percent of the world’s cotton. The U.S., the largest exporter, expects to see sales volumes plunge 21 percent, according to the U.S. Department of Agriculture, because Texas, the country’s top growing state, had the worst drought in at least a century.

Price fluctuations tempted some parties not to honor their contracts, helping push 168 disputes to arbitration as of Oct. 24, more than triple the annual average, the International Cotton Association Ltd. in Liverpool, England, said last month. One trader filed 30 cases, Olam’s CEO Sunny Verghese said Nov. 14 in Singapore, without identifying the company.

Through sourcing in Australia and its ginning mills, Olam gained “significant income revenue relative to peers,” Chief Financial Officer Krishnan Ravikumar said Nov. 14. While Olam faced some customer defaults and negotiations, “those are a small part of the total volumes we supply,” he said.

Fee Income

Olam aims to more than triple annual profit to $1 billion in 2016, expanding in cotton in Ghana, urea in the Republic of Gabon and dairy farming in Latin America.

Australia will boost exports to a record 4.2 million bales in the year that began Aug. 1. In the U.S., where Noble said it faced most of the defaults, cotton shipments are shrinking at the fastest pace in five years, the USDA said Nov. 9.

“We believe that Olam’s scale and ginning capacity helps generate a more stable fee income revenue from cotton relative to its peers,” Credit Suisse AG analyst Su Tye Chua said in a Nov. 15 report.

To cut risk in cotton, Noble is focusing on shortening the contract time and securing more collateral, CFO van der Zalm said Nov. 9. He said he didn’t think entering the ginning part of the business would help Noble.

“It’s difficult to speculate” on whether Noble faces further losses on cotton in the current quarter, he said.

Twelve analysts in the last month cut their net income forecast for Noble by an average of 22 percent, according to data collected by Bloomberg. Two analysts have raised their profit forecast for Olam and one cut it, taking the average down by 0.1 percent, the data show.

Cotton Futures

Cotton futures slumped from the record as global cotton stockpiles rise for a second straight year amid weakening demand. Futures which almost tripled in the two years through 2010, closed yesterday at 96.48 cents in New York, taking this year’s losses to 33 percent.

“The kind of volatility seen in the cotton market this year has not been seen since the U.S. civil war, so we believe that this is a one-off event,” former Noble CEO Leiman said on a conference call Nov. 9.

The worst is probably over for Noble, James Koh, an analyst with Kim Eng Securities Pte., said in a report. “This is a short-term blip.”

Olam faced a similar situation to Noble’s U.S. experience in the last fiscal year when Australia’s Queensland was hit by the worst flooding in 50 years, destroying cotton crops, CEO Verghese said.

Direct Hedges

To deal with the volatility this year, Olam set up direct hedges with banks as opposed to buying futures contracts on an exchange, Verghese said. An over-the-counter contract does not require collateral, the need for which grows as the price of the underlying commodity rises.

Olam also renegotiated cotton contracts with buyers after prices plunged to avoid defaults and avoided linking supply to acreage as opposed to volume, Verghese said.

Judging a company’s performance by the market it operates in is tough since the commodity suppliers do not disclose their trading volumes, RBS’s Rachmat said.

“As an investor you cannot do a fundamental analysis,” Rachmat said. “So you have to rely on more general principles. And if you find risk management to be of a somewhat doubtful quality, you draw your conclusion from that.”

--Editors: Keith Gosman, Andrew Hobbs

To contact the reporters on this story: Luzi Ann Javier in Singapore at ljavier@bloomberg.net; Yuriy Humber in Tokyo at yhumber@bloomberg.net.

To contact the editors responsible for this story: Rebecca Keenan at rkeenan5@bloomberg.net; James Poole at jpoole4@bloomberg.net


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