Following the placement, Temasek will be Olam's second largest shareholder with a 13.76% stake and will be given a board representation. Placement eases gearing, improves financial flexibility. The equity placement exercise will ease Olam's gearing ratio significantly. Assuming that the placement was concluded in 3Q09, the group would have reported an adjusted net gearing ratio of 0.31x, much lower than the 0.83x it reported. More importantly, the enlarged equity base will enable Olam to expand its debt capacity by up to US$600m. With the additional financial flexibility, Olam is better equipped to pursue organic and inorganic growth opportunities. The group remains keen on acquiring assets that are value- accretive. Although its move towards an asset-intensive model could lift the group's risk profile, management remains committed to investing only in projects that can reap returns in excess of the industry average. It has an IRR target of 20% and ROIC target of 12% (5ppt above its assumed WACC) for acquisition targets.
Downgrade to HOLD on valuations. Olam maintains its medium-term performance targets of 25% - 30% earnings CAGR and 20% ROE. We are leaving our earnings estimates unchanged, but our core FY09F EPS drops from 10.8 S cents to 9.3 S cents following our adjustment for the dilution. We view Temasek's strategic investment in Olam positively as it could serve as a platform for future growth opportunities. In addition, we believe that Temasek's financial muscle could support the group's expansion plans should the need arise. We have raised our valuation parameter to 17x (from 15x) in line with the STI's re-rating, bringing our fair value estimate to S$2.01 (previously S$2.06). Given yesterday's sharp appreciation, we downgrade our rating to HOLD.
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