Why Olam's earnings recovery story is finally starting to make sense

Profit trend boosts investors' confidence.

According to Barclays, the earnings and cash flow turnaround story for Olam seems to be coming together – with some idiosyncratic upside from weather patterns. 

The earnings trajectory in 1H14 seem to have given some confidence to investors and the prospect for the first absolute net debt reduction since its IPO looks tangible for 2014.

Here's more from Barclays:

In addition, the dry weather in California and Brazil (while unfortunate for the growers in the region) has led to an increase in prices for almonds (+10% since Jan and double since the trough in mid 2011), coffee (+50% in 2 months) and tomatoes (annual contract prices +18% y/y), and will provide tailwinds to Olam's earnings, while commissioning of agri terminal in Australia should also contribute to earnings.

We revise our FY14-16E earnings to reflect a higher exit rate for 1H14 earnings, but the events of the past two months could lead to c15-20% upside from these levels as well. We increase our DCF-based PT to S$2 from S$1.8 and reiterate our OW rating.

Severe drought in California, which produces c80% of global almond and c30% of US tomato (water intensive crops) volumes has resulted in spot price spikes for both commodities and potential earnings tailwinds for Olam. The company has access to the world's largest almond farm in Australia and one of the largest tomato processing capacities in the US.

Margins in the nuts and spices division was +c40% y/y in the Dec quarter, while continuation of this strength in margin could mean c10-20% y/y upside to annualized group earnings from this division only, in our view.

Coffee & cocoa – a healthy combination of long positions and strengthening prices: Coffee prices have risen c50% year to date, while cocoa prices have also been moving north.

Olam is long in both these commodities, with an annual traded volume of 1.6mtpa, but does not disclose the volume breakdown between products. However, we estimate that a limited flow through of prices into Olam's margins is capable of earning additional annualized EBITDA of S$130mn.