Investor Notes: Noble

Noble Group's logo.
Noble Group's logo. PHOTO: REUTERS

Against the backdrop of a prolonged commodity crunch, Noble Group reported on Thursday (Nov 12) another quarter of lower earnings in the three months to Sept 30, citing rising losses incurred via its mining and agricultural joint ventures.

But instead of dwelling on the reasons for the fall in profits, chief executive Yusuf Alireza took the opportunity to show investors the progress they have made in strengthening its balance sheet.

Among others, Noble recorded a positive cash flow and further reduction in debt level in the third quarter.

Between the persistent industry headwinds it continues to face and the signs of improved financials within the company, Noble will likely remain an open case for investors already jittery over its plunging share prices.

Noble Group is one of Straits Times Index's constituent stocks and ranked 77th in the 2015 Fortune 500 list, with a market cap of around S$3.07 billion

The Hong Kong based firm is a commodity trader with an asset-light business model. It shuns the ownership of assets such as mines, and focuses on the logistics and financing services involved in the trading of physical commodities.

These include energy, gas and power, as well as metals and mining products, with a total tonnage volume of 73 million tonnes in the third quarter and 206 million tonnes for the first nine months this year.

1. More cash, less debt

Noble was able to generate a net positive cash flow of US$318 million (S$451 million) from operations, achieving the positive cash flow target well ahead of the year-end deadline the management set for itself, Mr Alireza said in a conference call held on Thursday.

Having more cash was a big deal for the management in trying to calm the worried market watchers and show that it can properly service its debt. Noble had for the previous three quarters been unable to generate positive cash flows from operations.

Meanwhile, net debt fell by US$155 million in the third quarter to US$4.18 billion, or US$2.51 billion after adjusting to readily marketable inventories. Net debt to equity was 82 per cent, below the 98 to 313 per cent level among comparable peers, Mr Alireza added.

But it remains to be seen how sustainable the operating cash flow will be. Part of third quarter's gains may have come from Noble's recent move to sell off its metals inventories. Generating steady cash flow from core operations will be another matter, and perhaps a tall order given the difficult business environment.

This was already flagged by Moody's in August when it changed Noble's rating outlook to negative.

"Moody's acknowledges that Noble's liquidity risk is partly mitigated by the large amount of readily marketable inventory that the company holds and which could be used to repay debt. However, Moody's also notes that Noble's underlying commodity markets are inherently volatile and that the business is confidence sensitive."

2. Iceberg unconvinced

Following three months of silence, Iceberg Research emerged again on Thursday to challenge the positive view Mr Alireza painted.

"The net fair values are near their record high: US$4.5 billion, up from US$4.08 billion. Despite all the promises, Noble is unable to bring its mark-to-market down. The reason is that the MTM are largely manufactured. Manufactured assets are neither light nor heavy. They are immovable: they don't leave the balance sheet until they are impaired," Iceberg said in a blog post on Thursday after Noble's results announcement.

Fair values - estimates of asset and liabilities value or contract prices - are at the centre of the war of words Iceberg has waged against Noble since February. Iceberg alleged that Noble has exaggerated its fair values on the book via mark-to-market accounting to cover up cash and debt issues.

Notably, PwC stated in a review in August that Noble's contract valuations did not breach any accounting standards.

"Noble's net profit fell from US$155m to US$26m in Q3. What is remarkable is that the whole industry is recording large impairments but Noble is completely immune. Large mark-to-market (MTM) were recognised with shaky counterparties," Iceberg said in its latest lash-out.

Market watchers and shareholders have been unable to decide definitively which side is correct in this prolonged spat, but it would appear concerns still linger among investors, as Noble shares plunged 11 per cent to 44.5 cents on Nov 13, a day after the results announcement. This pushed the drop since February to around 58 per cent.

3. Cost discipline

No matter how the Iceberg saga pans out, it is important for Noble to focus on managing its businesses. Mr Alireza has repeatedly pledged that commitment, and part of that was reflected in the cost discipline Noble has shown.

Noting that costs have come down every quarter since the fourth quarter in 2014, Mr Alireza said on Thursday that Noble is on track to meet the annual cost saving target of US$70 million.

In the first nine months this year, Noble had significantly cut back on the cash used in investing activities to US$180 million, down 74 per cent year-on-year. Capital expenditures in the same period also dropped 83 per cent to US$56 million, while a headcount reduction of 15 per cent was also announced.

In his note on Friday (Nov 13), Jefferies analyst Abhijit Attavar added: "We would expect some savings in net interest expenses going forward as (Noble) has recently refinanced nearly US$730 million of debt at over 6.5 per cent interest rates with short-term credit.

"A clean spread of 5 per cent on US$730 million of debt itself should lead to US$35 mllion per annum of interest savings starting in 2016," he said, giving the company a buy call with a target price of $1.3.

4. Seeking partners

Noble also announced that it plans to raise at least US$500 million through "asset disposals and/or other strategic/financial transactions currently under discussion".

Mr Alireza however refused to provide more details on the potential transactions, only noting that the company will do what is in the shareholders' best interest.

But speculations have been rife for months as Noble's troubles persisted, with some hoping that a "white knight" will come to its rescue, similar to Temasek Holdings' move in 2014 to take over Olam and save it from further short-seller attack.

How feasible a takeover bid for Noble will come is anyone's guess, given its size and the global commodity crunch. For now, it seems more likely that Noble is not looking at that last resort. But the announcement could have a positive short-term impact.

"We believe that the current short positioning - with over 22 per cent of free float shorted - in the stock is getting too crowded. Noble's stated intention to raise around US$500 million through strategic sales could well be the trigger for a short squeeze," Mr Attavar said.