Commodities

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

The most daringly notorious commodity merchant in history raised an army, waged wars, plundered at will, sold opium to China, gave spectacular returns to shareholders, caused at least 30 European banks to collapse and was itself bailed out by taxpayers.

Thankfully, today's commodity traders are nothing like the East India Company. But even these businesses have ways of making and losing money that occasionally show a fleeting glimpse of that buccaneering spirit.

Time to Cough Up
Wilmar International's outstanding bonds and loans due

Take Wilmar International, whose shares have tumbled more than 50 percent since early 2012. Religare Capital Markets' analyst Nirgunan Tiruchelvam rates the stock a sell and has a target price about 35 percent lower than its current market value. He says half of the palm-oil and soybean trader's net profit in the first nine months of 2015 came from finance income, which was at least in part driven by investing low-cost U.S. dollar funds into high-yielding Chinese currency. That carry trade, which has got nothing to do with commodities, is now unwinding, thanks to a wobbly yuan exchange rate. 

Meanwhile, the company has almost $5 billion in outstanding bonds and loans that it has to repay or refinance by the end of 2021, according to data compiled by Bloomberg.

A Wilmar spokeswoman said it's inaccurate to characterize the company's exposure to yuan as a carry trade. The deposits reflect the local-currency revenue from Wilmar's extensive operations in mainland China, and, while the commodity trader has indeed earned a positive spread in the past on its U.S. dollar borrowings, hedging protects it from swings in the Chinese currency. 

Chalk it up to serendipity then, but isn't it nice to have billions of dollars in debt and yet be able to post positive net interest income? That, however, is what financiers do. The whole point of buying shares in a commodity trader is not to replicate the returns from an investment bank, but to acquire claims on a less risky earnings stream than what one could hope to get from a miner, oil explorer or cultivator. During a downturn, a Wilmar, Noble Group or Olam -- all three of which are listed in Singapore -- ought to be able to demonstrate they can effectively hedge against a rout in raw-material prices.

Yet that's not what the records show. Their aggregate earnings volatility over the past five years is hardly any different from the jumpiness in global mining companies' profit:

Close Ties
Traders' earnings volatility broadly tracks the global commodities cycle
Source: Bloomberg
* Number of standard deviations from five-year average earnings

Given the see-saw ride in earnings and share prices, investors in non-Japanese Asian commodity-trading businesses should ask themselves if their companies really belong in public markets. In some cases, the answer might be no.

Middle of the Road
How the trio's shares have performed over the past four years
Source: Bloomberg

Noble Group, battling allegations over its accounting practices amid a brutal slump in iron ore and oil, is already caught up in a bitter struggle for survival. Founder Richard Elman has bought the company's equity at least nine times over the past year, including a fresh purchase of 10 million shares Friday, and a similar amount Monday. Stock in Noble Group, though, is down 71 percent since early 2015. The company's 2020 bonds are trading at 57.37 cents on the dollar, versus 109.42 cents this time last year.

Finally, it's the traders' so-called readily marketable inventory that makes them unsuitable for public markets. It should in theory be quickly convertible into cash. But when short sellers attack or credit ratings get downgraded, the inventory has proved near impossible to liquidate. That's understandable partly because of the traders' dominance in some markets: Wilmar says it processes 35 to 40 percent of the world's palm oil. And in some cases -- like cashew nuts for Olam -- there may not be a futures market, Religare's Tiruchelvam says. 

Maybe it's time these commodity traders tweaked their business models. They could allow themselves to be taken private, paving the way for their operating assets --- with unexciting but steady revenues -- to be floated as investment trusts. That way, the really risky and rewarding part of the business, including carry trades, could be financed by private equity and bank loans.

Swashbuckling, albeit on a far more modest scale than what investors had to stomach two centuries ago, might be a tad too sensational for public markets to handle now.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net