Noble Group - DBS Research 2017-05-12: Profits Under Pressure

Noble Group - DBS Vickers 2017-05-12: Profits Under Pressure NOBLE GROUP LIMITED CGP.SI

Noble Group - Profits Under Pressure

  • Core of loss of US$125m in 1Q17.
  • Losses arising from inability to hedge effectively in the coal business.
  • Profitability to remain under pressure near term.

Risk of losses to continue near term. 

  • We maintain our HOLD call on Noble Group (Noble) with a revised TP of S$0.94. 
  • While Noble’s share price now trades at a significant discount to book (P/B of 0.2x), there are limited near term catalysts to trigger a rerating of Noble’s share price. There is risk that losses may continue due to the inability to effectively hedge the price risk in its coal business, and still negative operating cashflows.
  • Furthermore, there are questions surrounding Noble’s ability to secure sufficient liquidity from its key banks.

Where we differ – 

Recovery take time. 

  • Consensus is forecasting Noble to return to profitability over the next two years.
  • However, we believe the change in market structure of the coal market, flattening of the oil forward limiting the contango carry trade as well as higher costs of borrowings, may delay the recovery in profitability expected by the market.

Strategic partner the potential circuit breaker. 

  • Sentiment surrounding Noble is extremely negative at the moment.
  • However, the potential investment by a strategic partner such as Sinochem as speculated by various press reports, may provide confidence to investors and bankers about the strength of its business model and value of its assets. Similar to Temasek taking a majority interest in Olam, the strategic investor in Noble may act as the potential circuit breaker and help trigger a re-rating of the stock.


Disappointing losses - 1Q17 core loss of US$125m.

  • As expected Noble reported 1Q17 core loss of US$125m (net profit after dividend for capital securities, but excluding profit from supply chain assets), after Noble’s earlier guidance that it would generate a loss in 1Q17.
  • The loss was mainly triggered by losses in its coal business as Noble was unable to effectively hedge the price risk of its various contracts. Noble has historically used futures and swaps tied to the benchmark Newcastle thermal coal price. However, due to the lack of liquidity and influence of small traders, the Newcastle thermal coal price no longer moves in sync with the physical coal prices in countries such as Europe, China and Indonesia. As a consequence of the change in correlation, gains that were expected to generated from futures/swaps did not materialise to offset the drop in physical prices of various coal products. Profitability of the coal business was also partially affected by changes in the anchor price/long term prices used to value some of Noble’s coal contracts.
  • The loss generated in 1Q17 was despite Noble being able to reduced its selling, administrative and operating expenses (SAO) by 45% q-o-q to US$91m on a quarterly basis.

Weak overall segmental performance

  • Given the repositioning of the group and sale of Noble Americas Energy Solutions, the European Gas & Power business and reduction in the Metals trading activities, Noble’s group results are now reported under two segments. The new Energy segment combines the former Energy and Gas & Power segment and includes the Oil Liquids, Gas & Power an Energy Coal businesses.
  • Meanwhile, the Metals, Minerals and Ores segment, now consist of the former Metals & Mining and Corporate segments.
  • Owing to the losses in the energy coal business as described earlier and liquidity constraints impacting the oil liquids business, the new Energy segment reported a 89% y-o-y fall in gross profit to US$27m.
  • Meanwhile, the Metals, Minerals and Ores segment, reported a loss of US$29m, down from profit of US$49m recorded in 1Q16. The weak performance was attributed to difficulties in managing its hedges in the coking coal business, similar to the energy coal business. In addition, the segment’s profitability was impacted by the roll-off of a significant long-term iron ore contract.

Negative cashflows and deterioration in credit metrics

  • Noble continues to generate negative operating cashflows (-US$323m) albeit an improvement from – US$486m recorded in 1Q16. The negative cashflows continue to be impacted by increases in working capital (rise of certain commodity prices) and the underlying losses.
  • As a consequence, Noble’s net debt (excluding readily marketable inventories), rose to 42% from 33.8% as at December 2017.
  • With available cash of c.US$1.4bn and unutilised committed debt facilities of US$0.9bn and not forgetting its US$1.7bn worth of readily marketable inventories, Noble has sufficient liquidity headroom to repay its short term borrowings of c.US$1.7bn (which includes US$650m term loan). While some market participants are concerned about Noble’s ability to refinance/repay its borrowings and despite the challenges Noble faces, we believe its core bankers should continue to be motivated to provide sufficient liquidity to the group and maintain Noble as a going concern.

Board changes

  • In conjunction with 1Q17 results, Noble also announced that it would be making several changes to the board.
  • Mr Richard Elman will step down as Executive Chairman and will be taking a non-executive Board role as Founder and Chairman Emeritus. Mr Paul Brough, who is currently an Independent Non-Executive Director will step in as Chairman.
  • Furthermore, three non-executive independent directors, Mr Iain Bruce, Ms Irene Lee and Mr Richard Margolis will be stepping down from the Board.
  • Two of CIC’s representatives, Mr David Zhang and Mr Patrick Yu will be replaced by Mr Benjamin Bao and Mr Winston Ma who are executives with CIC.
  • Finally, Mr Jamie O’Donnell will be added to the board.

Near term profitability to remain under.

  • With the dislocation in the coal markets making it difficult for Noble to hedge effectively, and the opportunity to conduct the carry trade curtailed due to the flattening of the oil future curve, we believe Noble’s earnings will remain under pressure near term and extend the time taken for Noble to return to profitability. This is consistent with the Chairman’s comments that it may potentially take till FY18/19 for Noble’s profitability to be restored. Thus, we now project a core loss of US$336m in FY17 with losses narrowing to –US$21m in FY18. This compares to our previous expectations of a return to profitability this year.

Lowering TP to S$0.94

  • On account of potential losses continuing over the next few quarters, we have now pegged our valuation to 0.5x P/B versus 1x P/B previously. In addition, given the significant correction in sugar prices, which may affect the profitability of Noble Agri, we have removed the US$200m deferred payment from our valuation.
  • However, we continue to ascribe zero value for Noble’s associates/JV’s, intangibles and Level 3 assets. We have also assumed a USDSGD FX rate of 1.40 in our valuation.
  • Consequently, our TP has been reduced to S$0.94 from S$2.30 previously.
  • Maintain HOLD
  • With Noble likely to report losses for FY17, we believe there is limited re-rating catalyst near term. Thus, we maintain our HOLD call with a revised TP of S$0.94.

Key Risks to Our View

  • The key downside risk to our view is Noble being unable to secure financing from its banks. 
  • Upside to our view, would arise from Noble gaining a strategic investor and/or Noble delivering better than expected profits/cashflows.

Mervin Song CFA DBS Vickers | 2017-05-12
DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 0.94 Down 2.30