|Noble Group Ltd|
Unexpected losses, sustained cash burn with delayed turnaround, inadequate guidance leading to crisis of confidence
Noble reported an unexpected loss in 1Q17 and liquidity concerns increased materially from sustained net working capital outflows bringing usable cash levels to ~US$500 million pro-forma of loan repayment. Unsecured debt maturities are only in March-May 2018 and banks with unsecured exposure should try to support company (but move to secured debt structure) to wriggle out of current stress but liquidity risk could mount earlier if negative working capital sustains at current pace. It doesn’t help market confidence either that weak numbers and tight liquidity came to the fore just two months after doing a large bond.
With much uncertainty and lack of adequate response related to questions on liquidity, cash burn reversal or profitability, it is tough to take a directional view on the bonds and rather look to trade them as a pair till clarity arises. We also highlight the trade could be high risk as the situation is still fluid but we highlight the upside vs. downside potential in each scenario.
We believe it is a very close call for either scenario to play out (see page 3) but with management guidance that business is not expected to turnaround until 2018/19 at least, we think “kicking the can down the road option” may not help improve the tight funding situation as the debt on cap structure would remain unchanged.
We place slightly higher probability to a more comprehensive solution that the new management may prefer to improve the current tight situation which we think could be played by switching out of ‘18s into ‘22s (low dollar price senior debt) taking a view that all bonds would be treated equally post securing bank loans. Investor could also sell the perps and buy the ‘22s as we think the upside vs. downside on ‘22s is much better. Separately, with current capital structure, our base case in recovery scenario in liquidation is around 35-50 cents, the variable being assumptions on value of FV contracts.
- Noble’s results were weak on account of profitability, negative cash flows and higher debt. The company reported slightly higher revenues (US$12.6 billion from higher ASPs even as volumes continued to fall sharply by 16-22%yoy. Gross margins were however negligible and coupled with issues in the coal markets dislocations, EBITDA loss stood at US$66 million for the quarter.
- Specifically, Noble guided the correlation between Newcastle Energy Coal Price indices vs. China’s domestic coal prices have progressively eroded and hence led to losses from the resulting hedges. While Noble could revert to the agency model of moving commodities from place A to B for a fee, it adds uncertainty on value of the existing contracts or how profitable the new model would be given the highly competitive nature of that business.
- The results were not terribly weak by itself (loss of US$130 million) to suggest the steep 40-45pts fall in bond prices, we believe there are a few other updates that shook confidence – a) viability of profitability as expectations of 2017 turnaround delayed to 2018/19, b) high cash burn leading to tighter liquidity than expected post May loan repayment, c) losses happening just two months after new bond for issues prior to/around bond issuance, d) low visibility on turnaround implying cash burn-out in two quarters at this run rate.
- Given complete black-box nature of operations, inadequate disclosures of contracts even in broad / competition-safe terms, market confidence in the company has gone extremely low, in our view. A high churn rate in senior management does not help confidence either. While the new Chairman, Mr. Paul Brough, is not new to the company, his prior experience as restructuring officer for other Asian companies makes market (and us) connect some dots.
- Operating cash flows were negative US$376 million due to FFO loss and US$264 million in negative working capital from payables decline, inventory increase, FV losses and increase in margin with brokers which we think will increase further based on current situation. Noble also invested US$90 million in Harbour Energy to maintain 75% stake, increasing net debt by US$423 million, effectively funded by the recently issued bond.
- No debt maturity in the near term but that does not mean liquidity issues cannot arise. Cash balance stood at US$1.5 billion vs. our US$2.0 billion expectation (difference being the cash burn) of which US$350 million was locked with brokers. With repayment of US$700 million loan as guided, pro-forma usable cash would decline to ~US$600 million. Coupled with guidance on turnaround only in 2018 (limited guidance how this translates to cash burn turnaround), US$1.1 billion NWC outflow seen in 2016 and similar run-rate seen in 1Q17, concerns of cash levels further declining are legitimate, we think.
- That said, there are two buffers for liquidity. Including the two BBF it currently has, we think Noble has ~US$1.2 billion of liquidity (cash and unutilized secured lines), which it could theoretically use for profitable trades. While this structurally subordinates the bonds even more, it could give the company some room to wiggle out of the current stress and help primarily ‘18s.
- Separately, there has been recent excitement about a potential strategic partner with Reuters quoting Sinochem as a candidate, though none of the two companies confirmed. However, as noted in our report on Feb 14, 2017, we are not too excited about this yet as even if this does materialize it remains to be seen if the investment is done at the opco level or holdco group level. Note that Sinochem is primarily an oil trading company and hence rationally speaking, Noble’s US oil liquids business could be a strategic attraction for Sinochem to enter the US markets which it otherwise would find it difficult. The other businesses (energy and metallurgical coal, metals etc.) are not a strategic fit to Sinochem. This also gels with COFCO’s purchase of Noble Agri at opco level.
- We also tried to understand Noble’s ability to substitute more unsecured debt with secured debt but management didn’t give guidance even in any broad numbers. There are US$1.2 billion in unsecured loans due in May-2018, just after the 2018 bonds and in absence of capital market access and limited cash generation, we think ability to term out existing unsecured loans into secured could be tough. Theoretically, the company can liquidate some of its contracts but in recent past, it has not been willing or unable to do so.
- Given the ongoing stress, we think Noble’s trading bandwidth could further tighten along with risk of trade payables declining. Thus we attempt to do recovery analysis on the company (Table 4) but highlight that this will be a rather difficult process as bulk of the assets are FV of contracts where there is negligible publicly available information. As shown in Figure 3and Figure 4, the company’s trends of lack of ability to generate cash while running down FV contracts and that an increasing proportion of FV contracts is long term vs. short term valued are also downside risks to our recovery analysis.