4 biggest earnings headwinds that Noble must hurdle

Slower demand from China expected.

According to Maybank Kim Eng, given its assumption of flattish asset turnover and limited scope for further gearing up of the balance sheet (considering Noble’s current high gearing of 95%) a significant earnings turnaround depends on margin improvement. 

On this front, there are various earnings headwinds: lower demand from China, strong competition, more stringent regulations and low commodity prices. As such, a quick and structural margin improvement will be hard to come by before FY15F.

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We expect gross profit margin to only improve marginally to 1.8% by FY15F from 1.6% in FY12, but still far below FY10’s levels.

Challenge #1: Lower demand from China. It is commonly recognised that China’s economic growth will slow to a more normalised and sustainable rate.

Coupled with a greater focus on environmental protection and the shift to a more consumption-oriented economic model, China’s demand for certain commodities such as coal and iron ore is expected to grow at a slower pace. 

Challenge #2: Stiff competition. In the past decade, with growing global profit pools, a large number of new players came into the commodity trading business.

These new players include small independent commodity trading firms and financial institutions such as investment banks. Many commodity producers also set up their own trading units. 

Challenge #3: More stringent regulations. Another factor weighing on margins will be the more stringent regulations.

Although so far commodity trading is still a relatively unregulated area, we think it is possible that regulators will pay more attention to it, as some traders have grown so fast in the past 10 years that they are now systemically important.

More immediately, however, regulations for the global banking system will also affect Noble’s margins, in our view.

For example, under Basel III which will be fully implemented by 2017, banks will face stricter capital, liquidity and risk management requirements, which could result in less availability of letters of credit especially forhigher-risk counterparties, difficulty in raising syndicated loans as well as higher borrowing costs across all trade-finance products. 

Challenge #4: Soft commodity prices. Commodity traders are usually price-neutral. But as Noble moved more upstream in the past few years, low commodity prices have had a negative impact on its profit margins.

Also, high commodity prices are usually a result of tight supply, under which traders could profit from the arbitrage opportunities offered by price discrepancies. Noble’s gross profit margin has historically tracked quite well against the prices of some commodities.

As such, we expect only a slight gross profit margin improvement in Noble’s energy and MMO sectors for the next three years. We expect gross profit margin for the agriculture sector to rebound from a breakeven level in FY13F to 1.1% in FY15F due to low base, but still significantly lower than FY10’s 6.2%.