Olam International

Interesting comments from CY09 and Clement. Let's explore further.

@ Clement
I have excluded earning, and focused on asset, in the quest. Earning is a moving target. A company with "optimum debt (wref to earning) might become non-optimum overnight with changes in earning outlook.

An optimum debt (wref to asset), stays, with changes in earning outlook. In the event of poorer earning, asset should be liquidated to repay debt. Cost of debt,should be consistent with risk, thus a well-balanced structure (lower risk), should logically has lower cost of debt (competitive advantage)

@CY09
I agree Olam was lucky with the "backer". Both Olam and Noble were having vastly imbalance structure, thus the "crisis". I don't think I want to rely on the "luck", but something more reliable.

I would like to quote a case study, Trafigura, with net gearing of 3-4x, but continue to perform well, with amble liquidity, and good biz amid the global storm. The company has a well-balanced structure.

(not vested in Olam and Trafigure, vested in Noble)

(15-09-2016, 12:22 PM)CityFarmer Wrote: Interesting comments from CY09 and Clement. Let's explore further.

@ Clement
I have excluded earning, and focused on asset, in the quest. Earning is a moving target. A company with "optimum debt (wref to earning) might become non-optimum overnight with changes in earning outlook.

An optimum debt (wref to asset), stays, with changes in earning outlook. In the event of poorer earning, asset should be liquidated to repay debt. Cost of debt,should be consistent with risk, thus a well-balanced structure (lower risk), should logically has lower cost of debt (competitive advantage)

@CY09
I agree Olam was lucky with the "backer". Both Olam and Noble were having vastly imbalance structure, thus the "crisis". I don't think I want to rely on the "luck", but something more reliable.

I would like to quote a case study, Trafigura, with net gearing of 3-4x, but continue to perform well, with amble liquidity, and good biz amid the global storm. The company has a well-balanced structure.

(not vested in Olam and Trafigure, vested in Noble)

Hi CF,

I agree that an optimal debt level should take into account earnings outlook, which is why i focus more on the variability of the cash returns over time. I use sharpe ratio in this case as this is a trading company and i think the ratio is directly related to the theoretical optimal leverage multiplier.

I prefer to use cash earnings for such an exercise as i think the value of a business asset is related to its earning power.  In times when the earnings outlook for an industry has changed, it is likely that the assets involved will be less attractive, more difficult to finance and be worth much less on the market.

(15-09-2016, 12:45 PM)Clement Wrote:

(15-09-2016, 12:22 PM)CityFarmer Wrote: Interesting comments from CY09 and Clement. Let's explore further.

@ Clement
I have excluded earning, and focused on asset, in the quest. Earning is a moving target. A company with "optimum debt (wref to earning) might become non-optimum overnight with changes in earning outlook.

An optimum debt (wref to asset), stays, with changes in earning outlook. In the event of poorer earning, asset should be liquidated to repay debt. Cost of debt,should be consistent with risk, thus a well-balanced structure (lower risk), should logically has lower cost of debt (competitive advantage)

@CY09
I agree Olam was lucky with the "backer". Both Olam and Noble were having vastly imbalance structure, thus the "crisis". I don't think I want to rely on the "luck", but something more reliable.

I would like to quote a case study, Trafigura, with net gearing of 3-4x, but continue to perform well, with amble liquidity, and good biz amid the global storm. The company has a well-balanced structure.

(not vested in Olam and Trafigure, vested in Noble)

Hi CF,

I agree that an optimal debt level should take into account earnings outlook, which is why i focus more on the variability of the cash returns over time. I use sharpe ratio in this case as this is a trading company and i think the ratio is directly related to the theoretical optimal leverage multiplier.

I prefer to use cash earnings for such an exercise as i think the value of a business asset is related to its earning power.  In times when the earnings outlook for an industry has changed, it is likely that the assets involved will be less attractive, more difficult to finance and be worth much less on the market.

I reckon, our thought are aligned. I am focusing more on optimum structure, but you are more on operational detail. The proposal of sharpe ratio on trading company is new to me. 

Thank for the input, a very helpful one indeed.

(15-09-2016, 03:41 PM)CityFarmer Wrote:

(15-09-2016, 12:45 PM)Clement Wrote:

(15-09-2016, 12:22 PM)CityFarmer Wrote: Interesting comments from CY09 and Clement. Let's explore further.

@ Clement
I have excluded earning, and focused on asset, in the quest. Earning is a moving target. A company with "optimum debt (wref to earning) might become non-optimum overnight with changes in earning outlook.

An optimum debt (wref to asset), stays, with changes in earning outlook. In the event of poorer earning, asset should be liquidated to repay debt. Cost of debt,should be consistent with risk, thus a well-balanced structure (lower risk), should logically has lower cost of debt (competitive advantage)

@CY09
I agree Olam was lucky with the "backer". Both Olam and Noble were having vastly imbalance structure, thus the "crisis". I don't think I want to rely on the "luck", but something more reliable.

I would like to quote a case study, Trafigura, with net gearing of 3-4x, but continue to perform well, with amble liquidity, and good biz amid the global storm. The company has a well-balanced structure.

(not vested in Olam and Trafigure, vested in Noble)

Hi CF,

I agree that an optimal debt level should take into account earnings outlook, which is why i focus more on the variability of the cash returns over time. I use sharpe ratio in this case as this is a trading company and i think the ratio is directly related to the theoretical optimal leverage multiplier.

I prefer to use cash earnings for such an exercise as i think the value of a business asset is related to its earning power.  In times when the earnings outlook for an industry has changed, it is likely that the assets involved will be less attractive, more difficult to finance and be worth much less on the market.

I reckon, our thought are aligned. I am focusing more on optimum structure, but you are more on operational detail. The proposal of sharpe ratio on trading company is new to me. 

Thank for the input, a very helpful one indeed.

I believe our ideas are aligned as well.

To sum up my thoughts, I think the cash generation ability of the business and variability of expected future cash flows are key inputs for the optimal level of leverage, as they determine the probability of financial distress. While the payback period and liquidity of the assets will determine the optimal type and duration of the debt financing.

(15-09-2016, 04:38 PM)Clement Wrote: I believe our ideas are aligned as well.

To sum up my thoughts, I think the cash generation ability of the business and variability of expected future cash flows are key inputs for the optimal level of leverage, as they determine the probability of financial distress. While the payback period and liquidity of the assets will determine the optimal type and duration of the debt financing.

I agreed with an minor addition. I agree the optimal debt level is derived by the factors suggested. The ability to escape an financial distress due to whatever reason(s), will rely on matching liquidity between assets and liabilities.

Thank you

(sharing for a proper closure of our thoughts)

Besides matching Asset-Liability-Management (ALM), cashflow to repay and interest cover is important. For the lender it is also about collateral (if it's massively overcollateralised the previous discussion is moot) and business model. That's why IIRC even Modigliani realize that the optimal debt structure for different industry is different. I like Clement's idea of cash flow sharpe ratio theoretically but I'm not sure how effective this is in reality cause commodity prices tends to trend and not normal distribution.

If an asset is $100 and returns $10, both A&B companies buys it with $100 equity will have same return and same valuation.

But if A leverages by borrowing $100 now A will have $20(minus interest cost) income while B remains $10 income. The ROIC is the same $20/$200 and $10/$100 but the ROE and more importantly the cashflow differs. That's why businesses leverage, especially so if the margin is low eg $1 per $100. They don't just look at shareholders' or lenders' point of view. I would think the sharpe ratio is similar so the ratio alone might overestimate the expected future cashflow without considering the capital structure.

As long as one is in debt, it is a matter of trust. Even banks that loses trust in a crisis will succumb to bank runs. Olam and Noble are no different. If a person has $100 and his cheque clears for $99, he is still trusted. A person of $100k but cheque fails to clear for $$100,001 he is distrusted. It's perception.

(15-09-2016, 11:07 AM)BlueKelah Wrote: CF optimum debt is no debt or no net debt, but that's just me...

Sent from my MotoG3 using Tapatalk

I recommend no debt or net cash for individuals cause life is too short to stressed out by overleverage. But for companies it will just encourage complacency. Remember the TLC before the new mandate, or those cash rich companies sitting around and major shareholders not doing anything to the Structure part of the ABS

(15-09-2016, 10:16 AM)CityFarmer Wrote: I have a previous doubt, what is the optimum level of debt? Gearing (debt-to-equity) was the focus, but I have soon found that, it is a misleading indicator.

In the following scenario

- Asset $1
- Debt/Liabilities $0.9
- Equity $0.1
- Debt-to-Equity 900%

Am I playing with fire? May be. If the asset is having similar if not more liquidity than the liabilities, then it is as safe as fixed depositor, IMO. The best is having cash in well-run bank with %x rate, and debt/liabilities with <x% rate, I can safely pump it up to as close as possible to 10x gearing.

Then what is the optimum for debt? I reckon, the same concept as fund manager, the matching liquidity between asset and liabilities, otherwise, crisis is just a matter of time.

Olam, seems moving up the supply chain, with M&A activities, but funded with long term liabilities i.e. perpetual bonds and equity. It is the right move, IMO.

What do you think?

(not vested)

Commodity trader Olam hunts bolder deals after US$2 bil spree

(Sept 14): Olam International, one of the world’s largest food commodities traders, is targeting more acquisitions next year after a US$2 billion ($2.7 billion) spree since late 2014 involving deals in cocoa, peanuts and wheat.
...
The company’s leverage after issuing perpetual bonds in July is at 1.62 times net debt-to-equity on a pro-forma basis. That’s below its soft target of about 2 times. With net debt of $9.8 billion as of June 30, that would leave the company with a theoretical debt headroom that could be used for everything from dividend payments to capital expenditure, as well as acquisitions.
...
http://www.theedgemarkets.com.sg/sg/arti...-bil-spree

OMG, FWIW and IMO, you are wrong on the "high leverage ratio doesn't matter as long as asset duration are matched with liability duration" thesis.

cashflow, earnings, quality of assets, ROA metric matters too. finally, increasing leverage ratio to deliver earnings growth is not a viable nor sustainable business model. no good can come from that.

there's also the need to be the BIGGEST player and force out the competitions...
Size does matters and temasick is a strong backer!!! :O

(16-09-2016, 11:20 AM)getrich Wrote: OMG, FWIW and IMO, you are wrong on the "high leverage ratio doesn't matter as long as asset duration are matched with liability duration" thesis.

cashflow, earnings, quality of assets, ROA metric matters too. finally, increasing leverage ratio to deliver earnings growth is not a viable nor sustainable business model. no good can come from that.

High leverage is used by commodity traders for centuries.

Debt (the same for derivative) is a tool. It becomes dangerous under wrong hands, and used wrongly.  

(16-09-2016, 11:20 AM)getrich Wrote:

(15-09-2016, 10:16 AM)CityFarmer Wrote: I have a previous doubt, what is the optimum level of debt? Gearing (debt-to-equity) was the focus, but I have soon found that, it is a misleading indicator.

In the following scenario

- Asset $1
- Debt/Liabilities $0.9
- Equity $0.1
- Debt-to-Equity 900%

Am I playing with fire? May be. If the asset is having similar if not more liquidity than the liabilities, then it is as safe as fixed depositor, IMO. The best is having cash in well-run bank with %x rate, and debt/liabilities with <x% rate, I can safely pump it up to as close as possible to 10x gearing.

Then what is the optimum for debt? I reckon, the same concept as fund manager, the matching liquidity between asset and liabilities, otherwise, crisis is just a matter of time.

Olam, seems moving up the supply chain, with M&A activities, but funded with long term liabilities i.e. perpetual bonds and equity. It is the right move, IMO.

What do you think?

(not vested)

Commodity trader Olam hunts bolder deals after US$2 bil spree

(Sept 14): Olam International, one of the world’s largest food commodities traders, is targeting more acquisitions next year after a US$2 billion ($2.7 billion) spree since late 2014 involving deals in cocoa, peanuts and wheat.
...
The company’s leverage after issuing perpetual bonds in July is at 1.62 times net debt-to-equity on a pro-forma basis. That’s below its soft target of about 2 times. With net debt of $9.8 billion as of June 30, that would leave the company with a theoretical debt headroom that could be used for everything from dividend payments to capital expenditure, as well as acquisitions.
...
http://www.theedgemarkets.com.sg/sg/arti...-bil-spree

OMG, FWIW and IMO, you are wrong on the "high leverage ratio doesn't matter as long as asset duration are matched with liability duration" thesis.

cashflow, earnings, quality of assets, ROA metric matters too. finally, increasing leverage ratio to deliver earnings growth is not a viable nor sustainable business model. no good can come from that.

The question is, what is a viable or sustainable business model? If a business is able to pay its suppliers, labour and capital providers out of operating cash flows, how is it not viable? Does it have to be able to do so 100% of the time? If the company that is only able to do so 90% of the time, but is able to provide a higher return to capital providers to compensate them for the risk, i don't see it as not viable.

When discussing whether high leverage ratios are viable for a business, I think we should leave personal investment preferences out of the discussion. Let's be a little open minded, not all investors have similar risk appetites.