Noble Group: Cost of Capital and Deforestation Risks Under Priced? (Revised)

Noble GroupNoble Group Ltd. is a supply chain manager headquartered in Hong Kong, involved in the commodity trading of oil, coal, metals and palm oil. Five years ago, Noble group was among the 100 biggest companies in the world by revenue, generating it by purchasing physical commodities, transforming and then trading them. Since then, its shares value have decreased 90%. For the fiscal year 2015 Noble Group posted its first annual loss in twenty years, losing $1.7 billion due to significant reported impairments. These corresponded to allegations of misleading aggressive accounting overvaluing Noble Group’s commodity contracts.

Key Findings

  • Forecast of 2016 revenue is $46 billion, 30% below 2015, due to poor semi-annual performance and asset sell down strategy which may shave 4.5% off expected 2016 operating earnings, 18% annualized.
  • Impairments of palm oil assets and coal receivables may reduce balance sheet equity value by $400 million, or 12%. 33% of Noble’s palm oil landbank is undevelopable as it is primary forest and possibly peat. Coal assets are said to be overvalued by 30%.
  • Syndicate banks have been involved in the recent rights issue and are also involved in the divestment of North America Energy Solutions (NAES), suggesting a conflict of interest coupled with possible mispricing of debt and future increase in borrowing costs.
  • Net profit outlook for 2016 and beyond is below consensus due to divestments and expectations for higher interest rate. Risks for shareholders remain.

Sale of assets needed for loan repayments will shave off 4.5%, or $25 million off remaining 2016 operating earnings, 18% annualized. In 2017, $2 billion of Noble Group’s debt will mature with cash on hand at $1 billion and share issuance at $500 million. If Noble Group sells Noble Americas Energy Solutions (NAES) for at least $1 billion it could meet its upcoming debt repayments and achieve pro-forma net debt at 5.6 times EBITDA. Coupled with registering a net loss of $55 million for Q2 2016, the NAES divestment makes for revenue expectations at $46 billion.

Balance sheet equity impairment of 12% expected due to asset overvaluation. Impairment of palm oil business can be expected at 1.5% of balance sheet equity, or $50 million, because 33% of Noble Group’s 69,000 ha palm oil landbank in Papua Province, Indonesia is undevelopable – as it is primary forest and possibly peatland. Noble Group is taking a risk by already developing the land which may prove a breach of Roundtable on Sustainable Palm Oil (RSPO) principles; its corporate buyers’ No Deforestation, No Peat, No Exploitation (NDPE) policies; its bank’s sustainability policies; and infringe the government circular on peat. Further 12% of accounts receivables may also be impaired due to overvaluation of coal contracts, suggested by Iceberg Research. In total, $400 million or 12% of Noble Group’s balance sheet equity may be impaired.

Cost of debt may increase because of conflicts of interest and reputational risks. ING, HSBC, Morgan Stanley, DBS, and Société Générale are part of the 25 bank syndicate that provided a $1 billion loan to Noble Group in May 2016. In July 2016, the banks tried to minimize their risk exposure via underwriting Noble Group’s $500 million rights issue. HSBC and Morgan Stanley are also acting as advisors on Noble Group’s proposed NAES divestment, which would also reduce their risk exposure. As Noble Group is further in breach of its banks’ sustainability policies over deforestation, some of the banks may disengage. These two issues suggest that new debt costs for Noble Group may increase, driving further liquidity concerns. Credit rating agencies also suggest increasing costs of debt.

Net profit is reduced as cost of capital increases. Expectations for higher costs of debt could decrease net profit for Noble Group by 9% to $136 million in 2016 and $104 million in 2017. This further increases risks for shareholders.

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