Chain Reaction Research: Olam International – Deforestation Risks from its Peruvian Coffee Supply Chain
Coffee production has been identified by the Peruvian Agricultural Census of 2012 as one of the major drivers of deforestation in the Peruvian Amazon, making up 25.4 percent of agricultural land in this region. Smallholders with less than 5 hectares (ha) of land produce 62 percent of the coffee grown in the Peruvian Amazon, often applying shade-grown techniques. Smallholder coffee production and the expansion of the agricultural frontier by migrant farmers contribute to deforestation and forest degradation.
In 2016, Olam Peru was the second largest exporter of coffee from Peru with 13 percent volume share. Olam Peru has an important role in the coffee value chain. It purchases 95 percent of its coffee from smallholders through agents and intermediaries. Its parent company Olam International (Olam) has zero-deforestation goals, but policy implementation remains not fully adopted within Olam Peru’s coffee value chain. This exposes Olam to deforestation risks, which could result in reputational damage.
- Olam International has extensive environmental sustainability policies. Olam’s upcoming Global Forest Policy, will have a cross-commodity scope and may apply to Olam Peru’s coffee supply chain.
- Olam Peru is one of the largest coffee traders in Peru. In 2016, it accounted for 13 percent of Peruvian coffee exports. As most Peruvian coffee is produced for sale to export markets, Olam Peru has an important position in the coffee value chain. Olam Peru sources 95 percent of its coffee through a network of licensed agents, intermediaries and traders. Suppliers are selected on a day-to-day basis.
- Government institutions, research agencies and civil society have identified coffee as a major driver of deforestation in the Peruvian Amazon. Coffee has the highest land coverage and highest expansion rates of all commodities produced in the Peruvian Amazon. Small-scale coffee production and the expansion of the agricultural frontier by migrant farmers contribute to forest loss.
- Olam Peru uses certification schemes for parts of its supply chain. It applies its Livelihood Charter and Supplier Code to smallholders and intermediaries, but Olam Peru is unable to guarantee a zero-deforestation supply chain. Olam Peru does not suspend trading relations in response to non-compliance with its sourcing policies.
- Olam International faces reputational risk because of deforestation in Olam Peru’s coffee supply chain. It is unlikely that Olam faces possible loss of clients or regulatory sanctions because of Peruvian deforestation in its supply chain. If Olam Peru lost all its Peruvian coffee sales due to deforestation risks, it would have a negative impact of 0.5 percent on Olam’s enterprise value. Because of Olam’s high debt level, this would trigger a negative 1.6 percent impact of 1.6 percent on its equity valuation. This USD 60 million annual loss of client revenue would exceed the estimated USD 10 million financial gain from extra coffee sales by Olam Peru from deforested land.
Financial Risk Assessment: Conclusions
- Olam’s Confectionary and Beverage Ingredient segment contributed respectively 37 percent and 30 percent to its 2016 net sales and adjusted EBITDA. Olam should focus on managing the reputational risk of this important segment.
- Olam Peru’s coffee business generated about USD 100 million in sales in 2016, which is 2 percent of the Confectionery and Beverage segment and 0.7 percent of Olam’s sales. As the Confectionary and Beverage segment has a relatively low margin, its estimated EBITDA contribution from Peruvian coffee is 0.5 percent.
- Olam Peru’s deforestation risk will probably not lead to a loss of clients. However, if Olam Peru would lose all its Peruvian coffee sales this equals a negative 0.5 percent impact on their enterprise value. As Olam International is leveraged with a high level of debt, this would trigger a negative impact of 1.6 percent on the equity valuation. This worst case USD 60 million negative impact from a loss of clients would substantially exceed the estimated financials benefits of USD 10 million from the extra coffee sales from deforested land.
- Minority shareholders might be successful when engaging with Olam. As the Confectionery and Beverage segment is important to Olam, the company and its dominant shareholders could be willing to adjust their Peruvian policy.
- Olam has a high net debt/EBITDA. Of its gross debt, 70 percent is from bank credits and 25 percent from bonds. In credits, leading banks are in the syndicates. In bonds, leading asset managers hold stakes. As a majority of banks/investors have high scores on their deforestation policies, we should expect engagement about the Peruvian deforestation related to coffee production.
For more information, please contact Tim Steinweg.