What will it take for Noble to restore investor confidence?

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SINGAPORE (Oct 10): DBS Vickers Securities is maintaining its “hold” recommendation on Noble Group with a higher target price of 19 Singaporean cents, from 17.5 cents previously, after the Asian commodities trader today announced its sale of Noble Americas Energy Solutions (NAES) to Calpine Corporation for a sum of US$1.05 billion (S$1.44 billion).

Although the divestment further strengthens the group’s balance sheet, it will still take time for Noble to restore investor confidence in its business model, says DBS analyst Mervyn Song in a Monday report.

The analyst is therefore remaining cautious on the stock, given its “negative operating cashflows, volatile profits, and various credit agencies which continue to place Noble on a negative outlook”.

Near-term earnings to remain under pressure

DBS is now assuming the group will book a core loss of US$37 million (S$51 million) in FY16 before experiencing a recovery in FY17 with a core profit of US$93 million.

Song is convinced Noble’s earnings will remain under pressure in the near term, as it passes on trading opportunities to conserve its liquidity position, ahead of the receipt of the sales proceeds from NAES and the release of additional working capital in December.

“Combined with costs associated with closing capital-intensive or lossmaking businesses, we expect Noble’s earnings to remain under pressure until at least the completion of the sale of NAES in December 2016,” he adds.

Potential silver linings

There could, however, be higher returns from Noble’s now asset-light business model, as the group is currently exiting and downsizing businesses that were subscale or more working capital-intensive, says Song. Assuming Noble delivers on its plans, he believes there is potential for the group’s return on equity (ROE) to attain the 20% level in the medium- or long-term.

The analyst also foresees an opportunity for the group to gain market share from its smaller rivals or through expansion into new markets. This comes despite the downturn in commodity markets, which Song says will make the ability to drive volumes and margins “increasingly harder for Noble.”

What could earn Noble a re-rating?

Noble’s de-rating over the past 18 months was mainly due to concerns over its cash flow generation, as well as over the valuation of its associates and Level 3 assets. Song emphasises that at this stage, it is necessary for Noble to generate positive free cash flow “in a sustainable fashion”, in order to demonstrate the group’s ability to service its debt, as well as the value of its assets.  

For Noble to overcome investor concerns and achieve a re-rating, Song suggests either a partial or full sale of Noble’s associates and/or Level 3 assets, at or above stated book values — or securing a strategic investor, which would provide confidence over the long-term viability of its business model.

As at 4.45 p.m., shares of Noble are trading 6.77 higher at 20.5 Singaporean cents.