Noble @ 1.29 ( Supply chain / Hong Kong ) 2 comments
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1.Extraordinary quarterly collapse suggests tremendous operating headwind
2.Exposure to bulk shipping where rates are under pressure
3.COO sudden departure is suggestive
4.Realignment of segmental focus towards metal and energy-related commodities might pressure short-term margins
I will be accused of three things in my latest stockpick in this blog: firstly, of being short-termist since I am going to explain my choice primarily on account of its 3Q05 results; secondly, of ignoring its cheap valuations at 7 times trailing PE given its semi-blue chip status; thirdly, of changing my view so fast after enthusing about the stock in previous articles: in a comparison with Olam and in a tale about Noble's rise.
I usually focus on the medium term ie. 6 months to 1 year, in my purchases since I trade on a perceived trend (fundamental, not technical) and my experience is that this is the typical duration where any tangible share price impact of the trend will materialise. In the long term we're all dead, says Keynes. I shall explain a few key points in Noble's latest quarterly statement which reveals indications that the story for the stock may be a bit less rosy.
The clearest take-home point is that stripping away extraordinary gains from its stake sales in an Australian mining company, Noble's 3Q05 results saw a collapse in margins with a net profit of probably S$10-15M (compared with S$80M in the corresponding 2004 quarter). This was despite a near 50% increase in revenue over the same period, suggesting a collapse in margins to <1% from the average 2-2.5% recorded in 1H05. That is quite a spectacular collapse.
Those who think Noble is a pure supply chain manager is very wrong. Noble operates more than 100 ships under its logistics division. In 2004, despite revenue from supply chain management outweighing logistics operations by 10:1, profits from the latter actually outweighed that from the former by a reverse ratio 2:1. This clearly indicates the importance of the shipping operations to Noble. Noble deals in bulk shipping ie. transport of commodities like grain, metals, coal etc. This is the shipping segment which has seen a collapse in rates, as indicated by the Baltic Dry Index. That is definitely a main reason for the drastic fall in 3Q05 margins.
Yet it does not tell the whole story. Two points: firstly, the BDI had begun to drop since Jan 05 and reached a low in June 05. Yet the company had been chugging along smoothly for 1Q05 and 2Q05, growing revenues by about 50% which have helped to compensate for the slight drop in margins (from ~3.5% to ~2.5%). Seems like the headwind has finally had an effect on Noble in 3Q. Secondly, the departure of COO Gary Mize prior to the 3Q05 results announcement can now be seen in context as the likely result of a finger-pointing exercise over the poor 3Q results; it suggests deep execution problems which produced worse than expected results even though downward pressure on profit margin (from low bulk shipping rates) was probably expected way in advance.
The near future does not look good. The <10 trailing PE valuation is not really cheap if one considers forward PE might be higher if 4Q performance mirrors the 3Q disaster, and if one considers Noble as a bulk shipping play (since 60% profit comes from its shipping operations) where peers like STX Pan Ocean trade at <5X PE. Similarly, using such a comparison, its >2X NTA valuation looks ripe for a price correction, in comparison with other shippers. The company has been borrowing heavily (through bonds) to re-position itself in the targeted revenue segments of industrial commodities eg. metals and energy-related commodities (eg. coal & ethanol), with a shrinking emphasis on agricultural commodities (35% to 25%). Industrial commodities, especially steel, have undergone a correction due to oversupply in China; energy supply margins might be better on first look but don't seem to have contributed much given the poor 3Q profits despite a doubling of energy segment turnover. Interest payments have near quadrupled to $18M/quarter, from $5M previously. All these are going to act as deadweights to medium-term operating performance.