The CLSA analyst (Swati Chopra) had been following Olam for some time now, and had

previously issued negative assessments of Olam. In Chopra’s most recent report, a strong conviction to “Sell” finally had the media scrutinizing and publicizing the sell-side’s analyst concerns about Olam, and forced Olam’s CEO Sunny Verghese to openly challenge Chopra’s claims, in a bid to re-instill investors’ confidence, after Olam’s share price dropped 9.5% about an hour after the market opened. The major concerns highlighted in the analyst report are: 1. Export Incentives in Nigeria, and whether Olam’s profit is over-reliant on such incentives 2. Reporting differences raise questions and doubts about Olam’s internal controls 3. How the concerns above have “inflated” the true economic value of Olam’s share – Mispriced Risk. (Negative EVA) 1) The export incentive scheme was introduced to encourage exports of certain products from Nigeria, which will help Nigeria’s economy grow. The scheme was introduced in the form of an Export Expansion Grant (EEG), and CLSA estimates that a significant chunk of export incentives received are from Nigeria. CLSA concluded that the EEG ranges from 5-30% of the FOB value of an exporter, depending on the value of produce, and size of the exporter in Nigeria. Therefore, CLSA feels that since Olam is the largest Agricultural exporter in Nigeria, they will receive preferential EEG rates, which will contribute significantly to the profit of Olam. How? Because the grants are issued as Negotiable Duty Credit Certificate (NDCC), which can be used to pay off some of Olam’s import duties therefore, the grants serve as an alternative to cash payment and can be viewed as a form of “cash inflow” or “cash equivalents”. The accounting standards require grants to be recognized in 2 ways: 1) Credited to the P&L, and presented separately or under “other comprehensive income”. 2) Deducted in reporting the related expenses, which is COGS in Olam’s case. By deducting against COGS, expenses are lowered

as most investors look at a firm’s ability to control and sustain their earnings in the long run. then a relative portion of reported profits are volatile and “risky” because it will depend on external factors which Olam cannot control.g 20% to farmers (by paying farmers more) and to end consumers (by absorbing costs and selling at a lower price). To address the export incentives issue. Another major concern is how sustainable are these incentives. based on CLSA. a larger portion of the reported earnings will be contributed by these incentives. This is alarming for investors. Olam rebutted by showing that CLSA’s estimate of 3040% was wrong. Olam will be able to report higher earnings in the short run. the Nigerian government are bound to withdraw such incentives sooner or later (as seen by the lowering EEG rates over the years. and if no incentives were passed on. or demand higher risk premiums to offset the higher risk which they are now taking. it would still make up 35% of Olam’s profit. the contributed margins are relatively high. if “incentive contributed earnings” are acceptable due to industry norms? Well. Because if Olam’s profit relies largely on these incentives. and will give investors a false sense of security.and reported earnings for the current period are increased. so the more export incentives Olam receives. in fact. then it would make up 30-40% of Olam’s profit. are such incentives an industry norm? CLSA also showed that even if Olam passes some percentage of incentives e. the amount of Nigerian incentives for FY2010 was only 0. thus by “building” such incentives into COGS. So one major concern is how much of Olam’s reported earnings are attributable by these incentives? Also. and this is because Olam had taken into account the overall consolidated revenue of the group.8%. Also Olam argued that they are not the only exporter enjoying such “favorable” EEG rates. other . the withdrawal of incentives on cotton export and suspension of export incentives in 2007 and 2008). if they are not guaranteed the firm’s “reported earning power”. they will quickly sell their shares. Olam subscribes to this accounting treatment.

which will help diversify Olam’s income contribution. Thirdly. It was also historically shown. Secondly. I feel that Olam’s explanation . This is because of Olam extensive presence in 65 countries. but Olam’s reply was because in FY08 certain group companies sent through COGS net of export incentives to be consolidated without breaking it up and hence showed only S$2. and more importantly. and lastly. that even if Nigeria were to withdraw these export incentives. Firstly. the cash balance in the cash flow statement for FY08 and FY09 was different. the 2008 export incentive amount restated in 2009 annual report was lower by S$69.9m in 2008 AR to S$125.9m. are the reporting differences. the audited expense of PPE was significantly higher than the unaudited AR. how can Olam increase the COGS figure for 2008 in the 2009 AR and not adjust the reported earnings downwards? This just doesn’t make accounting sense. On such grounds. I am agreeable with Olam that they are definitely not over-reliant on the export incentives given by such emerging countries. they have most likely gained economies of scale. strong supplier relationships. and sustainable earnings. that even when India withdrew their export incentives. Olam was still able to produce stable margins. ADM. it will not impact Olam’s reported earnings significantly. and given their strong presence in such markets.17m. Armajaro also receive similar rates. it seems that Olam is trying to pose healthier reported earnings in 2009. On the surface. therefore they are not solely reliant on any particular market (they receive export incentives from only 5-6 countries). and since it was already netted off in the COGS for FY08.players like Cargill.9m in the 2009 report for the year 2008. the realized loss on derivatives was also restated from S$134. because they would have income sources from mature markets where their earning power is much stronger. Chopra highlighted that there are significant differences between audited and unaudited statements. 2) The second concern raised by Chopra. no adjustment was needed.

it should increase FY09 beginning retained earnings by S$9m.seems reasonable to justify why there is no need to adjust 2008 net income. then where is the retrospective adjustment to the beginning retained earnings for FY09? If the adjustments were made. as to the reason for reclassification? From which accounts are the figures reclassified to? The third concern is about the cash balances for FY07 and FY08 being different between the audited and unaudited AR. is that from a pure accounting perspective it is not possible to reclassify between realized and unrealized losses. but I would raise the question of why/how Olam could consolidate the groups’ accounts without standardizing the presentation? Was there not enough disclosure in the line items for FY08 and FY09 to make Chopra raise this concern? My view on the second issue relating to the difference of S$9m between “realized loss on derivative” figure reported. the bank overdraft was netted off against cash equivalent of A/R to show S$187.64m for FY07. the losses are booked into that period’s net income. moreover. and if Olam reclassifies a certain amount from realized to unrealized loss. This was attributed to the fact that in the unaudited AR. I feel that Olam has not adequately addressed the problem and attributing it to calculation errors and collation difficulties is just not acceptable. Assuming that it is justifiable to decrease the realized loss figure. but there was no impact on reported net profits after restatement. Moreover. if Olam wants to attribute the difference to reclassification. calculation errors and the difficulties of collating data across multiple operations. overdrafts were presented under “short term Loans from Banks”. but in the audited AR. I feel that there is no basis that can justify such a reclassification. The same treatment was done for . So where did the S$9m go? Olam attributed this “accounting phenomenon” to reclassification. then there should be disclosures and adjustments (which was not seen in 2009 AR). then they should give more specific details. once it is classified as realized. which will perhaps show a healthier financial position to Olam’s stakeholders.

because the revenues earned from such assets are properly matched to the relevant expenses incurred in that period. .e. the reason was due to the differential treatment at subsidiary level and at consolidated level. therefore. such as the asset’s balance sheet value. then investors do not need to be concern. which was basically a reclassification between “Purchase of PPE” and “Acquisition of assets as a business combination”. thus it will not affect financial ratios such as the current ratio and quick ratio which investors look at to measure a firm’s liquidity and financial health (i. However.FY08. Also the reclassification is only a shift of numbers within the “Cash Flows from Investing Activities” section. so that Olam can calculate the depreciation on value excluding for example purchased goodwill attributed to the price of the asset. fair market value and any goodwill associated with the asset. thus it will not adversely impact investors analysis of the Cash Flow Statement. which from my understanding is to split the purchase price paid for an asset into various classes e. Olam also mentioned that the reclassification has no impact on depreciation and/or profits. The last concern is about the audited expenses on PPE being significantly higher than the Unaudited AR. I feel that Olam’s explanation is reasonable and since the treatment has no major impact on the financial statements as a whole. the firm’s ability to meet their debts). So if what Olam claims is true. Olam claims that as they were integrating new acquisitions they are required to conduct a purchase price allocation. and the effect on the financial statements is that it will decrease the cash and short-term payables equally for both financial years.g. Olam only finished the purchase price allocation after the unaudited AR was released. investors need not be too worried about it. and this is important to ensure the matching of revenue earned from such assets. they claimed that they have made the appropriate final adjustments. which means to say that the assets were depreciated all along.

Given that EVA is calculated by taking the Capital Spread (ROIC% . investor’s use the capital spread as an indication of a firm’s value creation and if the firm’s capital spread is positive.WACC%) multiplied by the Invested Operating Capital (or Total invested capital). Also. as Olam and Ernst & Young were not required to take any actions regarding the reporting differences. and to break in down further. the Cost of Debt and Cost of Equity and Beta figures are also not shown. Chopra claimed that Olam’s ROIC is lower than WACC (even if using a Singapore cost of capital). thus CLSA cut their target price to S$1. this is contrary to what was reported by Olam which showed a positive capital spread from FY2008 to FY2010. any material changes in financial statements between the unaudited and audited version need to be signed off by Olam’s auditors (Ernst & Young) and a public disclosure via Exchange must be made. is regarding Olam’s negative EVA. therefore the difference in the WACC figure calculated by Olam and CLSA could be due to these 3 components. then the discrepancy in EVA value calculated by both companies is definitely attributable to the calculation of Capital Spread. 3) The last major concern raised by Chopra. so how can the results be so different? Olam and CLSA did not disclose the cost of capital used to calculate the WACC. as the . I feel that only the S$9m difference between realized losses on derivative for FY08 has not been properly addressed by Olam. Generally. a 46% downside with conviction to “Sell”. then there is no cause for worry over the reporting difference. another point to note is that for Singapore listed companies.In Summary of the reporting difference issues. it means that the investors are getting back higher returns on their invested capital as compared to the minimum rate of return (adjusted for risk) that a company must earn to create value for its shareholders. Chopra mentioned that with all the issues highlighted. Thus if investors trust these control policies put in place.6/share. Olam’s share price warrants a significantly higher risk premium and consequently a lower multiple. and Mispriced Risks.

While Olam has adequately addressed most of the concerns raised. Is it proprietary information? Will it erode Olam’s competitive advantage? Based on the efficient market theory and investors rationality. Also geographical contributions data is important to help the public determine the firm’s value. given the complexity of Olam’s operations.g. CIMB and HSBC did not question the Capital Spread calculation.g. Therefore. investors constantly look for more information to help them revise their assessment of Olam’s value. sample size of data used. in order to eliminate changes between unaudited and audited AR e. this will help users of their AR understand why certain figures need to be reclassified. however.Invested Operating Capital can be calculated from the items on the Balance Sheet. Olam will need to weight the cost and benefit of additional disclosure. and information asymmetry. The difference in the calculated capital spread could be attributable to different assumptions used by Olam and CLSA. for example. e. effort and a great deal of understanding in finance. Generally. I believe Olam can take some additional actions to prevent future misunderstandings. . Given these recommendations. a detailed disclosure on Nigerian export incentives. I feel that Olam’s EVA and Capital Spread are within the positive range because given the current situation Olam would not want to provide inaccurate figures to avoid further scrutiny. which would be available to the public through Olam’s audited or unaudited AR. Lastly. Firstly. standardizing across subsidiaries how to report figures (net or shown separately in line items) and secondly. this takes time. Another reason is because other analysts covering Olam. more detailed disclosure is needed to help the public understand Olam’s business and industry better. the group needs to strengthen its consolidation process. and contributions from such incentives would help the public come to a better conclusion of Olam’s firm value. transparency in choice of accounting treatment of certain accounts is necessary. earnings sustainability and identify possible areas of risk. which not every investors have.

most analysts whom did not accept the company’s data/forecasts/explanations. CLSA is no longer under the list of analyst covering Olam stocks. and underwriting revenue is earned when analysts are able to “satisfy” the underwriting firms with more optimistic forecasts. . Analyst play a very important role in the capital markets (e. 4) The Underwriting effect suggests that analyst’s pay are affected by the amount of underwriting revenue he helps his house generate. 3) Stickel (1992) showed that an analyst’s forecast accuracy is related to the analyst’s reputation. But are analyst forecasts actually unbiased and accurate? Here are several factors that can impact an analyst’s forecast. However. highly reputable “star” analysts were more pressured to outperform their untitled peers. this is a direct example of the “punishment” for giving a less optimistic assessment. b) more likely to be hired by a better house and c) more likely to be assigned to cover reputable company’s stock. thus they can do a more in-depth analysis. if you visit Olam’s website today. because they are a) less likely to be fired. interestingly. 5) Conflict of interest exists between analysts compensation and the accuracy of their forecasts 6) Fear of being “left out”.g evidence show that top companies bid for “star” analyst to have them cover their more important stocks) as the public is likely to give more weight to what an analyst says compared to other sources of information. it is interesting to note that point 3 can help mitigate the underwriting effect. simply because they are 1) trained in finance 2) more experience in valuing companies 3) have a good understanding of the industry which they cover 4) have access to better information.sell-side analysts serve their clients by analyzing information about the company and giving their opinion about the firm’s value. 1) New analysts prefer to “follow the crowd” due to their lack of experience and fear of being scrutinized by the public/media. 2) Studies also showed that analysts are systematically rewarded for being optimistic in their forecast. where are either replaced by another analyst or firm altogether or excluded from analysts’ meetings.

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