Noble Group - DBS Research 2016-01-04: Confidence Shaken

NOBLE GROUP LIMITED N21.SI

Noble Group - Confidence Shaken

We maintain our HOLD call and revise our TP lower to S$0.42.
We believe it will take time for Noble to restore confidence in its business model and the valuation of its associates and Level 3 assets (offtake agreements). For example, despite Noble strengthening its balance sheet through the proposed disposal of its 49% stake in Noble Agri, sentiment continues to be fragile, given Moody’s decision to downgrade Noble’s credit rating below investment grade.

To overcome investor concerns, we believe the following initiatives may help to re-rate Noble. These include:
1. a partial or full sale of its associates and/or Level 3 assets at or above stated book value to demonstrate the value of these assets; and
2. strategic investor in Noble itself or one of its divisions to provide reassurance over its business model.
However, ultimately Noble has to demonstrate a sustained improvement in its free cash flow generation and earnings growth to support any re-rating.

Given continued weakness in various commodity markets, we believe the ability to generate earnings growth is increasingly getting harder. Nevertheless, we still expect growth largely from Noble picking up market share from its smaller competitors and expansion into the energy and power markets.

Disposal of 49% interest in Noble Agri Disposal of 49% interest in Noble Agri Over the Christmas break, Noble announced it had agreed to sell its 49% stake in Noble Agri to COFCO International Limited for US$750m in cash, with the additional retention of upside participation in the future growth of Noble Agri, worth up to US$200m.
This follows previous press reports indicating Noble was looking to sell its interest in Noble Agri. The entire proceeds of the disposal will be used to pay down debt.
Post the transaction, Noble will also no longer need to provide a corporate guarantee for Noble Agri's borrowings. Combined with a reduction in debt, Noble believes its financial metrics are well in excess of those required of an investment grade rating.
In addition, Noble disclosed it would book c.US$546m non cash loss due to the difference between the carrying value of Noble Agri and initial consideration of US$750m. The transaction is subjected to shareholder approval, and we understand that it will close before the end of February 2016.

Moody’s downgrades Noble credit rating Despite the positive actions taken by Noble, Moody’s downgraded Noble’s rating to below investment grade, from Baa3 to Ba1. It has also placed a negative outlook on Noble’s credit rating. However, the other two rating agencies, S&P and Fitch have so far retained their investment grade rating on Noble.
Key reasons stated by Moody’s for the downgrade include:
1. low levels of profitability,
2. consistent negative free cash flow from core operating activities, which excludes proceeds from asset sales,
3. potential negative impact on Noble’s access to funding and profitability, given Moody’s view of a prolonged commodity downcycle.
We also understand that Moody’s had also downgraded other commodity companies, given its more cautious stance on the commodity market.

We are positive on the disposal of Noble Agri as it strengthens Noble's balance sheet and increases the likelihood of the group retaining its investment grade rating with S&P and Fitch. On a proforma Sep15 basis, Noble's total borrowings will drop from US$5.5bn to US$4.7bn or US$4.5bn including the potential US$200m deferred payment. Total cash and readily marketable inventories remain at US$1.3bn and US$1.7bn respectively. Meanwhile net debt (excl. RMI)/equity would drop from 49.3% to 38.7% or 34.3% (including US$200m retention amount).
Nevertheless, the boost to Noble's balance sheet may be temporary if Noble decides to invest US$500m in X2 Resources, the timing of which is still uncertain.
In addition, given that Noble has sold its stake in Noble Agri below its stated book value of US$1.3bn, we believe its critics will use this transaction to reiterate their view that Noble has overstated the value of its assets on its balance sheet. In our view, this would likely cause further volatility in Noble’s share price.
On the unexpected decision by Moody’s to downgrade Noble’s investment grade rating, this may make it incrementally harder for Noble to access liquidity and/or bond markets. However, the full impact is still uncertain as S&P and Fitch have maintained their current investment grade rating on Noble.

With still weak sentiment and Noble yet to demonstrate a sustained improvement in its cash flow generation, we maintain our HOLD recommendation. However, we have lowered our TP to S$0.42 from S$0.49 as Noble sold its 49% stake in Noble Agri below its stated book value.
We value Noble at 1x P/BV but attribute zero value for Noble’s associates including Yancoal, Level 3 assets and intangibles.
In addition, we now impute US$950m (initial US$750m consideration plus potential retention upside of US$200m) valuation for its stake in Noble Agri, down from US$1.3bn previously.
With the disposal of the Noble Agri stake, Noble will no longer be accounting for Noble Agri’s losses in its associate income line from end February 2016. Thus, we have raised our FY16-17F core earnings by 30-49%.

The key risk to our view is Noble securing a reputable strategic partner which would provide confidence over the valuation of Noble’s assets which are being challenged by investors and its ability to generate sustainable positive free cash flows.

Mervin Song CFA DBS Vickers | http://www.dbsvonline.com/ 2016-01-04

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 0.42 Down 0.49