S&P has given Noble a deadline of three months in which to raise a lot of capital, or else be downgraded to BB-, junk status. In addition to the warning by S&P, we are concerned about Noble Group’s financial reporting and realization of gains on commodity contracts, derivatives during Q3-2015. Excluding Derivatives MTM, Noble Group’s adjusted working capital is down to 685 million -47% from 3 months earlier.
Working capital has been reduced twice as much as their sales, essentially temporarily lowering their inventories and allowing its books amount of cash to show a positive amount.
The reported 500M$ gain on the oil hedge is not seen justified by the normal course of their hedging activity and was more likely to cover their working capital shortfall.
We currently have a SELL on the stock with a price target of S$0.10.
Source: Commodity Merchant Trading and Shipping Advisory Services CMTSA Research- 23 Nov 2015
CURRENT IMPLIED VALUE OF NOBLE GROUP : –0.006 SGD/SHARE.
PRICE TARGET: 0,099 SGD/SHARE.
By Tyler Durden from Zero Hedge
The name Noble Group should be familiar to frequent readers from our August 18 report on the company, but to those who are unfamiliar here is the quick summary: because it is Asia’s largest commodity trader, Noble can be better thought of as Asia’s Glencore.
As a further reminder, on August 18 we said that “we expect a big announcement of S&P on Noble Group later this week” as a result of the ongoing deterioration in the company’s fundamentals as well as various market-traded securities, notably its stocks and default swaps.
As usual, S&P was late, but just over three months later, the rating agency finally came out with the catalyst we have been expecting when moments ago it said that it had “placed its ‘BBB-‘ long-term corporate credit rating on Hong Kong-based supply-chain management service provider Noble Group Ltd. and the ‘BBB-‘ issue rating on the company’s senior unsecured notes on CreditWatch with negative implications.”In other words, Asia’s Glencore is about to be junked.
Here’s why, from S&P:
The CreditWatch action reflects our view that Noble’s liquidity and financial leverage have weakened and breached levels that we consider appropriate for the current rating. However, management’s commitment to raise new capital could support the company’s credit profile.
Noble’s liquidity deteriorated in the third quarter of 2015 following a 27% decline in the company’s net available readily marketable inventory to US$1.48 billion as of September 2015 from US$2.0 billion in June 2015.
The deterioration was largely related to the fall in commodities prices. The company’s available and undrawn committed credit lines fell almost 50% during the period to about US$1 billion. The company’s cash sources are less than 1.5x cash uses as of September 2015, below the threshold for a “strong” liquidity assessment.
Worse, S&P has given Noble a deadline of three months in which to raise a lot of capital, or else be downgraded to junk, a rating which could effectively end its trading business, and ultimately could lead to a liquidation of the entire company.
The rest of the note:
Noble’s financial leverage is also weak for the rating. The company’s ratio of funds from operations (FFO) to debt is 19.8% as of September 2015 on a rolling 12-month basis. This is a similar level to that in June 2015, but down from 24% in March 2015. In our view, the company’s cash flow and earnings visibility are poor amid a challenging market.
We expect that the company will commit to its stated strategy of focusing on profitability, and having prudent working capital management and cost controls to help offset market volatilities.
We believe the Noble management’s commitment to raise at least US$500 million in new capital could help restore the company’s liquidity position and financial leverage, which will be key to maintaining the current rating. In our opinion, if Noble were able to raise at least US$500 million in capital to offset its outstanding debt, the ratio of FFO to debt could improve to about 22%. The company has a good track record of raising capital through recycling assets and attracting new investors, in our opinion.
We aim to resolve the CreditWatch placement in three months. We will review Noble’s liquidity trends and financial leverage to see if the company’s capital-raising and cost-cutting measures are adequate to weather the heightened volatility in the global commodities market.
We may lower the rating by one notch if: (1) Noble’s liquidity does not improve, such that its cash sources are unable to cover uses by at least 1.5x.
This could happen if the company is unable to raise sufficient capital per its commitment or its cash generation and working capital controls are weaker than we expect; or (2) Noble’s financial leverage does not improve over the next three months, such that the ratio of FFO to debt remains below 25%.
This could happen if the company cannot raise new capital or if its earnings and profitability deteriorate. We could lower the rating by two or more notches if both conditions above are not met within the next three months.
We could also downgrade Noble if the company’s trading risk position weakens. Possible indications of such weakness include increases in fair value relating to long-term commodity offtake contracts, concentration risk of counterparties, or lower cash realization of commodity contracts than the company expects.
We could affirm the rating if we believe the weakening of Noble’s liquidity is temporary and the company has a credible plan and shows strong execution to restore its financial strength. Noble’s ratio of cash sources to cash uses staying above 1.5x and its FFO-to-debt ratio rising above 25% on a sustained basis could indicate such improvement. At the same time, we expect the company to demonstrate continued cash realization of marked-to-market gains and prudent risk management of fair value financial assets, including offtake contracts.
Just like for Glencore, a downgrade to junk would trigger an unknown amount of collateral and margin calls, promptly sucking up the company’s liquidity.
Which probably explains why Noble’s CDS which was trading at ~700 bps when we first profiled the company more than 3 months ago, has since doubled.
And November 23:
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Finally, for those who missed it, here was the original Noble Group report courtesy of Simon Jacques
Trust is everything in commodity trading, it is also what is maintaining a constant risk premia in this market.
Noble Group is Asia’s largest commodities trader.
According to GMT research, Noble Group took what they have estimated as between $4 to $6 billions worth of fair value gains on asset valuation over the last 5 years.
Just prior their Q2 earnings release, we published the reasons outlining why we believe that the trader is an accounting hocus-pocus.
Since we are exactly one week after their Q2 results, in theory Standard and Poor’s had time to do their homework.
We expect a big announcement of S&P on Noble Group later this week.
UK insurers (who have also a foot in the cargo insurance market) have dumped Noble Group bonds overnight.
The S&P downgrade was leaked or they have just anticipated it.
Bonds maturing 2020 now trading in mid 80’s; private bank clients waking up to risks? Company no longer has access to capital markets.
6 months after repeated assurances from Alireza that the financial accounting inquiry’s findings would not trigger a scramble for capital, 5 yrs CDS paper quoted at 743 bps, stands at the highest level since 2009, 100bps bid-ask
Energy credit analysts wonder where Noble Group’s financing will come from going forward with the downgrades.
The trader will lose its access to their counter parties because of stricter limitations to deal with them now.
[ Our Commentary on Noble Group Q3 results]
What is interesting about Noble Group is not so much their net income, its how they get there… It seems déja vù for Asia’s largest commodity trader ( the way they view asset impairments in coal JVs, the MTM gain they described on commodity contracts (~+500M$) during 3Q…
Noble Group should be judged Balance-sheet for Balance sheet.
I. A Y-T-Y jump of almost 50% in tonnage to 206 millions MT with sales down -20%.
Excluding Derivatives MTM their adjusted working capital is down to 685 millions -47% from 3 months earlier.
How can they reduce their working capital twice as much as their sales?
This inventory turnover is inconsistent with the normal treasury flow of commodity trading activity.
The company, presumably did not want its September 30 balance sheet to report a negative cash balance, so liquidating 520 M$ of inventory (likely by an accounting pen prior to issuing financial statements), has allowed its book amount of Cash to temporarily show a positive amount (a temporary gain that will be reverse in Q-4)
The Financial reporting during Q3 is contrary to the logic.
One can only awkwardly compare this company to (Mitsui, Glencore, X2…).
Noble Group is in a class apart.
II. As we take Noble Group’s definition of “liquid and ready marketable inventories” + cash margin with respect to the net fair value of commodity contracts and derivatives that they have with brokers and counterparties,
they have now a shortfall of 1.5B$ compared to 354M$ 3 months ago or about the same as on December 2014 (1.47B$)…
III. They still maintain have this huge MTM (unrealized gains on derivatives and commodity contracts).
This time, a new gain on these “hedges” was justified by the management as gain on the oil hedge (~+500M$).
During Q3, oil prices were down by 11% while they claim they did a gain on oil hedge of 500M$ oil prices.
Could it be justified by their trading activity ?
They traded 48.8 million MT of Oil during Q3, we see a gain on oil hedge of 241M$ possible with a 56$ to 49$/bbl average decline on 34476 contracts (1000 bbls per contract).
The reported gain on MTM cannot be explained by the normal course of hedging activity and was more likely to cover their working capital shortfall.
Another likely explanation is that Noble do simply more than hedging. (Taking speculative bets with the purpose to book profits from the direction in which prices will be moving).
What Noble Group is Worth ?
Noble Group is traded at 0.41 SGD per share on the SGX and by the models it seems that the equity market is currently not implying that Noble Group has to raise the 500m$.
Without any capital raising, the current implied value of Noble Group is -0.006 SGD.
With the 500 M$ capital injection the Price Target is 0,099 SGD.
In other words, the share price is roughly linear while the models aren’t.
So we are back to the fundamental question and initial dilemma:
Noble Group must raise money but has this problem: the Net Positive fair values gains of commodity contracts and derivatives exceeds many times Noble’s equity.
With respect to the potential private equity or institutions approached by Noble, there is a fair warning at all times- to inform investment expectations that subsequent changes in the Net positive fair value gains on commodity contracts booked by Noble Group are possible and, indeed, likely.
Noble Group belongs to a special class apart but sophisticated investors do not leverage companies with poor economics and transparency.
Any potential private equity or sophisticated fund investors approached by Noble should know that the Banks aren’t provided with the access of the exact breakout and PwC has not been able to review the exact assumptions and models behind the Net Positive fair values gains of commodity contracts and derivatives of Noble Group.
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