Why Cocoa is one of our crown jewel businesses – Sunny Verghese

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Olam International Ltd.’s Sunny Verghese – Co-Founder and Group CEO, spoke with Editors on the group’s Q4 2018 Results and their strategic plan for years 2019 to 2024. Excerpt:

 

Good morning, Sunny. Alfred from Bloomberg : Do you see the tough market conditions you highlighted in the results will continue this year, especially, for Coffee business?

Do you agree that what we see in the Coffee market cannot reflect to the market fundamental and why is that?

On the Cocoa business, you were doing quite well in the past years and are you going to keep expanding the Cocoa supply chain? Do you have any price outlook for the Cocoa in coming years?

And for the palm prices, do you think El Nino is still in the picture, do you have any expectation or forecast on the palm production in Malaysia and Indonesia for this year? And the last question will be about the downward risks for this year, do you think Asian Swine Fever ( ASF) will be a big risk for the total agriculture complex for this year?

 

So starting with your first question on Coffee, Coffee has had in terms of supply and demand and the balance sheet, potential $9 million surplus combined Coffee surplus is robust on Arabica coffees.

We, however, feel that there would be some revisions to this balance sheet through the course of this year.

We expect lower crop in the Central American and the Andean of 1.5 million bags.

We expect potentially a downward revision in the Colombian crop by about a million bags. Because of the fairly difficult weather in Brazil in the last two months, December and January, we expect further reduction in the Brazilian crop of about a million bags.

So overall, we expect about 4 million bags potential revision to this balance sheet, in which case the 9 million bags combined surplus could be revised down to about 5 million bags.

That will mean the end use ratios in terms of stock to consumption in Robusta coffee will be around 25.5% and in Arabica it will be about 33%.

This combined with a record short position by the specs on the terminal markets so our estimate is now there is a 70,000 lot short position, which is equivalent to almost 20 million bags, that’s a fairly unprecedented short position. So if you have any further weather-related surprises, this market could potentially rally. However, based on fundamentals, given the significant stock overhang, the market reflects fair value.

The other big factor in this equation would be what will happen to the Brazilian real. If the Brazilian real continues to strengthen or the Brazilian real potentially devalues, I think, the Street has taken the new administration’s economic team as a competent team and therefore there is a likelihood that the Brazilian currency would remain stable or strong and some part of coffee price direction is a result of what happens to the Brazilian real.

So I don’t think any of these markets for long-term would be mispriced or divorced from fundamentals. So I think the thesis that you alluded to that coffee prices are not reflecting fair value is probably not accurate. However, if there is these revisions that we expect in the balance sheet, that would be positive to coffee prices.

As you saw in the last couple of days, Coffee prices have breached $1 and come down to $0.96, $0.95, $0.97 set kind of range, that would mean that in many countries the cost of picking the coffee itself many people will not pick all the coffee. They will not use all the agricultural inputs in terms of fertilizers and pest management controls, et cetera, because the viability or the profitability is lower. In many countries, now coffee prices are below the cost of production.

And more importantly, in South America, we are now facing a major labor shortage. So labor wage inflation is quite high. So if it makes it even more expensive to pick coffee that is really trading at below cost then that could also impact total harvest. So that’s the coffee story. As far as the cocoa story is concerned, we believe that the 2018, 2019 crop was in equilibrium and there was a very small surplus.

However, we had very strong demand. So production and supply was more or less balanced with a little bit of surplus as far as supply was concerned, but we have had very strong robust demand growth.

So Grains grew by about 4.8% last year largely driven by growth in Asia, Eastern Europe, the former Soviet Union, Africa and the Middle East. So the nontraditional emerging markets showed very high consumption growth.

Globally consumption grew in terms of grains growth by about 4.8%. In the next coming crop, we expect a slight surplus, our estimate is now 100,000 tonnes surplus. And we also see a significant growth in share in Côte d’Ivoire.

So a couple of years ago, Côte d’Ivoire contributed roughly 40% of world production. There has been significant growth in supply from Côte d’Ivoire.

Now, it is contributing almost 47% of production. That is likely to continue to remain strong.

Ghana is likely to remain very strong in the production. We expect strong production in Cameroon.

‘We expect weaker production in Nigeria and in Indonesia, but we also expect a strong production in Ecuador.’

But the sum total of all of this supply side and demand side factors that I have mentioned is that we will see about 100,000 tonnes surplus that is our in-house estimates for the next crop ’18/’19.

But demand we think will also taper off 4.8% grain growth is significantly above historical trend line growth, so to 2 to 2.2% is stock will trend line growth, 4.8% is quite high, so we think that will moderate back.

And, therefore, our outlook on Cocoa prices is that it will trade sideways with London trading between 2,100 and 2,700 is our range of where Cocoa prices will pay during the course of this year.

We have to, however, watch out for weather developments during the rest of the season and based on how they pan out that could have an impact on the scenario that I just outlined. So that is as far as Cocoa is concerned. I think the third question that you had was on Palm? The question was on whether we will continue to expand.

Yes, we will to continue to expand in the Cocoa business. So as far as the Coffee business is concerned, we will continue to expand the soluble coffee business.

I think our green coffee business is right sized. There will be some incremental growth in select origins and trade flows. But we will continue to invest more in our soluble coffee business as explained in our strategic plan.

As far as the Cocoa business is concerned, we will continue to profitably grow that business. Yesterday, we made an announcement of making $90 million investment in acquiring cocoa processing facility in Indonesia, which is the largest processor by capacity.

The capacity of this facility is significantly higher than the current utilized capacity. So we will make sure that we debottleneck as we go along and get to full capacity utilization.

We also said in addition to the acquisition costs of $90 million there is a CapEx plan to get this business to full potential and that is really driving the trajectory of increased demand for powder in the Asian markets across ASEAN and also East Asia and South Asia, including India, there is a significant growth in chocolate consumption and cocoa powder consumption and that is why we will be continuing to invest and grow that business as well.

The third question you asked was on palm oil. You saw palm oil prices rally in January and as well as in February and that is primarily a seasonal issue.

We see a low seasonally the first quarter is always low production quarter and typically there is a rally in prices.

Overall, we expect the growth of roughly three million tonnes of palm oil production this year in Indonesia and Malaysia combined. Most of that increased supply will be absorbed by the higher biodiesel demand as a result of the B20 implementation in Indonesia and the B10 biofuel policy implementation in Malaysia. That will account for absorbing some of this increased production surpluses that we will see this year. But demand in China and India is also growing very strong. Some of this will also depend on the resolution to the trade war between the U.S. and China. China is importing more palm oil as a result of slapping a hefty duty on soybean.

And if there is a resolution to this trade war, which is the scenario that we now expect based on all that we are hearing from both sides, if that does happen then soybean prices are likely to rally and therefore the differential between soybean complex and the palm complex are likely to widen, which will allow palm prices also to rally to get back to what we think is relative value between the two complexes. So that is a story as far as palm is concerned. And I don’t have a view on AFS, the last question that you raised, but somebody from my team would be happy to get back to you on what potentially that impact would be. Thank you.

 

Aradhana Aravindan from Reuters: I just want to go back to the Indonesia acquisition that you announced two days ago, if you can elaborate a little bit more on why Indonesia? You mentioned a little bit about the ASEAN consumption for cocoa and also in that case since you’ve said you’re going to continue to invest in cocoa, can you – will it be through acquisitions? Are you looking for more acquisitions? If yes, would the deal size be around the same $100 million?

 

So in our cocoa processing portfolio, Indonesia was the missing piece.

So we had very strong configuration of assets and processing footprint in Africa, both in Côte d’Ivoire and in Ghana and in Nigeria.

We have a strong footprint in Europe across the U.K., Holland, Germany, in terms of our processing and manufacturing footprint.

One of the missing pieces for us was Indonesia and with this acquisition, we have completed that footprint. And that will make us – strengthen our global presence.

We were already processing in this facility that we have acquired on a tolled [ph] basis.

So we have had good understanding of the facility, the cost competitiveness of the facility, the potential of the facility.

So the risk for us is very low because we have been working with this partner in this same facility for almost two years, so that’s why we have invested there. What I mentioned is that, as far as the Cocoa strategy is concerned it is one of our crown jewel businesses.

We believe that we have very strong win-ability in that business in terms of a very differentiated business, very strong organization strengths. We are out-origin our competition, very strong processing capability, very privileged access to customers there for the customer franchise. We have very strong innovation and research capability.

So in each of these areas we will continue to invest. So it’s not acquiring a facility that I was referring to when we said we will continue to invest in growing our – or extending our lead in the Cocoa business. It is in all of these areas where we have differentiated and which is necessary for us to build a global market-leading Cocoa business.

I’m Kevin, I’m with Nikkei Markets. Okay I’m not that familiar with Olam, but you said that you want to expand your Nuts business, but earlier in the presentation, you spoke about what you call downsizing or cutting back on your peanuts business in Argentina. Can you kind of reconcile the two and perhaps for my benefit just explain broadly how the Nuts business is going to be grown?

 

Yes. So as far as the Nuts business is concerned, we have many SBUs within the Nuts platform, so one is almonds. We intend to continue to grow our investments in the almond business.

 

Today, the almond business has an upstream business and then a supply chain and trading business and then ingredients business. The upstream, which is a plantation business, we seek to grow our acreage in almond plantations, particularly in the U.S. to better balance our upstream assets in almond business between Australia and U.S. We have a significantly larger plantation footprint in Australia compared to the U.S. So we will want to increase our almond footprint in the U.S. as an example.

We are making a very big push into ingredient manufacturing in almonds, which is converting almond into value-added ingredients. There is a growing demand for these value-added ingredients across the globe and that is a trend that we want to capitalize on.

The second business for us in the Edible Nuts portfolio is a cashew business. We’re already world leaders in cashew business and as Muthu explained, last year, we made an additional investment in taking a 30% stake in Vietnam’s largest cashew processor/exporter, Long Son, is an example of how we want to continue to grow our cashew business even further. We will continue to expand our Africa cashew processing footprint in select geographies.

We will continue to grow our sourcing and origination reach and therefore increase our market share in the various cashew producing countries. Cashew is grown in 19 countries around the world. We are present in almost every one of them and we will continue to strengthen our penetration and our origination reach to grow our market shares in cashew. The third business there is hazelnuts. We will continue to organically grow our hazelnuts market share, particularly out of Turkey. And fourthly, we have pistachios.

We will continue to look for opportunities to grow our pistachio upstream footprint, mainly in the U.S. And in a few years’ time, we will look at Iran, which is another important producer of pistachios. So we will continue to see growth in the pistachio business. The walnut business, so we will maintain that business at current levels. There will be some increase in trading volumes but unlikely we will invest more in upstream walnut plantations. So that then brings us to the question of peanuts. So in the peanuts business, we have three activities.

We have peanut farming activity, which was in Argentina. In Argentina, we leased the peanut farming land and in the lease model, structurally you will be challenged to make money across cycles because every year or every two years you have to renegotiate the lease fee for the land. And based on competing alternative crops that can be planted like soybean, et cetera, the lease fee will change every year. That then changes your cost of production every year. Then all of peanut growing in Argentina is really rain fed, not irrigated. So you are exposed to higher agricultural risk. If there is a drought or there is a weather-related rainfall issue, et cetera, you increase your agricultural risk. So we have decided that if we can’t irrigate and reduce agricultural risk, for example, then it is not good for us to remain in that investment for the long-term. So we have decided to exit the peanut upstream investment, but we will continue to grow the rest of the peanut business.

What does the rest of peanut business contain for us? One is, we have an ingredient manufacturing business in the U.S. We are the largest independent peanut processor, which means we take peanuts and convert it into peanut paste, or other peanut value-added ingredients. That’s an extremely profitable business. We have a very strong competitive position. We are going to continue to expand organically the capacity in peanut ingredient manufacturing in the U.S. Then we have a peanut shelling business. Most of you would know in the last couple of years, we made two acquisitions, McCleskey Mills and Brooks, and we had combined the two businesses and we have become now amongst the top three peanut shellers in the world.

That business also we will continue to invest and grow. So the only peanut piece that we are under emphasizing is exiting the peanut upstream farming business. So overall, Edible Nuts business like the cocoa business is another one of our crown jewels and I mentioned in my strategic plan announcement that we will disproportionately invest in the Edible Nuts business as well to grow.

And we have very high relative market share compared to our next biggest competitor, which reflects that we have a very differentiated Edible Nuts portfolio and therefore we can profitably scale and grow that business.

Anita Gabriel from Business Times: The last time we met, I know it wasn’t too long ago, you mentioned that your asset divestment could unfold as early as within the next 12 months?

Since then, however, the global environment has weakened. I’m wondering, if any of this has made you reset the expectations of the time line on your asset divestments?

No. So we are progressing that, and we are pleased with the trajectory of our discussions and negotiations on these assets. As I told you at the strategic plan review, we are in no hurry to sell those assets.

There is no gun on our heads that this should be disposed of tomorrow. And we will do absolutely no kind of fire sale of any of these assets. So we will do this in an organized way, in a responsible way from a position of strength. But to answer your specific question, as to is there any developments in the last month or two, since our announcement, I think it is a month ago that we announced, right? So since that time no, there isn’t any change we see in the environment. So we will be continuing with our execution plan to selectively divest those assets that have been identified, which are now no longer aligned to the priorities of our new strategic plan.

Another follow-up question because you’re involved in array of businesses, I was wondering which spots or which areas, do you think present the most significant risks over the next six to 12 months? Okay. So the agribusiness is exposed to inherent cyclicality and volatility. And it is very difficult to forecast, which would pose cyclical risks, that will depend on, for example, if you are in the plantation business a lot of those risks are agriculture related risks. So what happens to weather?

While we can try and predict a little bit better now than in the past that it is not very easy to establish what the rainfall is likely to be or whether there is going to be a drought or a flood or whether there’s going to be extremely dire temperatures, all of that is difficult to predict.

All that we can say is that, the 12 businesses that we’ve chosen to continue in are all businesses where we have differentiated positions and where we feel we have clear win-ability, and we have a strategy that will allow us to navigate through some of the risks that you have sort of identified.

Having said that, based on the first question that was asked, we continue to see some headwinds in the Coffee business for the first half of this year and therefore Coffee business margins will be under pressure in the first half. For the other businesses, I think, there are normal trading conditions in. So I don’t see anything that I need to highlight particularly, but I think, the Coffee business will continue to face some headwinds in the first half of the year.

Simon Jong from DBS : Can I just ask, just with regards to 2018, we saw a significant improvement in terms of the volumes and at the same time, the general sense is that working capital has come down through the optimization measures.

I’m just wondering, considering both of these in tandem, how are you able to achieve the higher volumes with lower working capital and is that something that is sustainable for the medium to long-term?

That is the first question. And the second one is that I also observed, specifically, within 4Q, that there was a significant jump in terms of the bill – I mean the yes, payables and almost one billing, can I just understand where is that coming from?

Great. So I think there are two questions are interlinked and there are probably a few things there. So one is the product mix, the second is the business model mix, and both that impacts our cash-to-cash cycle. So for instance if you are buying, if a lot of the volume increases happened from Grains trading, and there we are doing bulk business, very short cash-to-cash cycles, we can buy from large farmers, stock trade houses and therefore availability of supplier credit is possible for that kind of business.

So if the product mix and the business model mix is – provides us the flexibility to do it on a much shortest cash-to-cash cycle as well as good supplier credit, that will determine some part of what is sustainable out of the supplier credit increase that you saw or the cash-to-cash cycle mix or the cash release that we’ve been able to achieve. So we think, if you look at based on a sustained or sustainable cash-to-cash cycle for our portfolio mix on an average across all the products, 90 to 100 days is probably what is a sustainable product mix. For last year, we are down to 75, aided somewhat by the significant increase in our bulk volumes as well as well therefore the supplier credit available against that.

So on an overall basis, we would guide towards more a 90 to 100 days, which would be very optimum balance on a cash-to-cash cycle basis. That will be impacted by commodity cycle, that will be impacted by supplier credit and the cost of that supplier credit compared to a cost of financing, and that will determine the actual outcomes on an ongoing basis. So again, like I mentioned in my previous thing, there are parts of our free cash to cash, free cash flow release of the last two years and our improvements in cash-to-cash cycle, which are sustainable, which is the operational efficiency part that we’ll stay focused on. Some part of the commodity price and some part of suppliers’ credit availability and cost of that will determine on market conditions and our product mix.

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