The 3 Numbers That Lubricate Olam International

OlamLogoIt is hard to believe that a company with a low profit margin can deliver an above-average Return on Equity. But Olam International (SGX: O32) not only can but it also does.

Olam is an integrated supply-chain company. It processes agricultural products such as nuts and seeds and supplies them to customers around the world. Its Return on Equity of 11% is a smidgen above the return for the 30 companies that make up the Straits Times Index (SGX: STI).

But what’s interesting is Olam’s very low profit margin. It is just 2.1%, and that is not a one-off. In 2011 it was 2.7% and in 2010 it was 3.4%.

Thing is, Olam is a price taker. In other words, it does not have too much control over price. When harvests are good and produce is plentiful, the price of the stuff that Olam sells could come under pressure. Consequently, if overheads stay unchanged, then profit margins are likely to suffer.

However, Olam has two levers that it can pull. The first being its Asset Turnover, which is a measure of the amount of revenue it generates from every dollar of asset used in the business. In Olam’s case, its Asset Turnover of 1.3 is more than twice the average for the 30 companies that make up the benchmark index.

Olam also uses leverage to deliver its above-average Return on Equity. It’s Leverage Ratio of 3.9 is more than twice the market average. Put another way, Olam is able to generate a decent return on equity for its shareholders by using other people’s money.

Worryingly, Olam’s Return on Equity has halved from 24% in 2010 to 11% last year. That has largely been caused by the decline in the net profit margin and the fall in the asset turnover. If this should continue then Olam will have to work even harder to maintain its ROE, which has been the product of a net income margin of 2.2%; an asset turnover of 1.3 and a leverage ratio of 3.9.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.