Noble’s shock Q4 loss: Why no warning?
2 March 2015
Business Times Singapore
WHEN the share price of commodities firm Noble Group stabilised very shortly after a selloff following the release of a report by short seller Iceberg Research a fortnight ago which attacked Noble’s accounting practices, the market had high hopes that Iceberg’s criticisms would be easily dismissed and the attack quickly repelled.Two weeks later, the market is now not so sure. Noble’s shares on Friday resumed their downtrend, plunging 8 per cent after the company reported a shock US$240 million loss for the fourth quarter ended Dec 31, 2014, largely due to an unexpected US$438 million writeoff.
Since a main prong of Iceberg’s attack was the need for more writeoffs, it looks very much – notwithstanding Noble’s protestations that Iceberg’s arguments have no basis and are wrong – that the short seller wasn’t too far off the mark.
The first and perhaps most obvious question is: Why was there no profit warning from Noble? When it reported its nine-month figures last November, the company announced a year-on-year trebling of net profit to US$372 million – and there was no negative hint of what was to come in the fourth quarter.
The average full-year earnings forecast of 13 analysts tracked by Bloomberg was US$470.6 million, which means the market had expected the fourth quarter to yield a profit of about US$98 million and not the US$240 million loss.
If the full-year figure of US$465 million had been achieved, it would have represented a stunning 91 per cent increase over 2013 net earnings; instead, the actual profit announced last Thursday of US$132 million, which incorporates the shock Q4 loss, represented a 46 per cent drop.
If the company knew that the market had got it so vastly wrong with its estimates, then as a blue chip institutional stock that is a component of the Straits Times Index, it should have intervened earlier rather than risk delivering a large negative surprise at the eleventh hour which, predictably, had such adverse consequences for its stock price and the index.
The problem is that it looks very much that no profit warning was made because none was thought necessary – at least until Iceberg entered the picture, by which time it was too late.
Iceberg asserted that Noble’s Australian-listed associate Yancoal
- a) should not be treated as an associate because Noble only owns 13 per cent and does not have a material say inYancoal’s affairs; and
- b) should have its value written down by as much as US$600 million to bring it closer to its market value.
Point a), whether or not Yancoal is an associate or long-term investment requires professional judgement and, because it would be difficult to nail down a definitive answer, the benefit of the doubt must be given to Noble.
However for b), things are a bit more interesting. The US$438 million impairment charge includes US$200 million for Yancoal.
In other words, even though Noble has consistently maintained that Iceberg’s research is flawed, misleading and has not affected Noble’s results in any way, it did indeed take a large impairment for the value of Yancoal carried on its books, thus adding some legitimacy in the mind of many observers to Iceberg’s thesis. It may not have been the full amount of US$603 million that Iceberg claimed was necessary, but an additional writeoff against profits of US$200 million is unquestionably significant.
So when exactly was the decision made to factor in the total US$438 million writedown?
In its briefing on Thursday, Noble said it started reviewing its balance sheet a month-and-a-half ago, which would have made it the middle of January. However, in response to Iceberg’s first report dated Feb 15, Noble on Feb 16 said that “there has been no material adverse change since the company last reported”, suggesting nothing had changed since its glowing nine-month release in November.
The words “material” and “adverse” are key here since they suggest that in the four weeks or so between the start of its balance sheet review and the Feb 16 announcement, Noble had not decided to materially mark down the value of associates and investments, Yancoalincluded, or issue a negative earnings guidance.
For all intents and purposes, the market then took this to mean the company was on track to meet full-year expectations, which is possibly why selling pressure eased very quickly after an initial selloff.
Yet a few hours before it released its final figures last Thursday (Feb 26), Noble said its external auditors Ernst & Young needed “more time to review their own internal processes in the light of third party allegations before signing off on the accounts”.
This is a very odd statement which, on a simple reading, implies that Iceberg’s allegations prompted the auditors to hurriedly review their work before giving the green light.
Did this hurried review then prompt the US$438 million impairment charges? If it did, what about the efficacy of Iceberg’s other claims? Including the absence of a profit warning, these are the questions now swirling around in the market’s collective mind and lie behind the current alarming weakness in Noble’s shares. The faster they are answered, the better.