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Here’s Why Ezra Holdings Limited and Noble Group Limited May Actually Deserve Their Shocking Price Declines
Offshore support services provider Ezra Holdings Limited (SGX: 5DN) and commodities trader Noble Group Ltd (SGX: N21) have received lots of attention from market participants as a result of their stunning price declines. Over the past 12 months, Ezra’s shares have sunk by nearly 75% in price while Noble’s shares have lost half their value. It’s been a painful experience for investors in the companies, to say the least. To add insult to injury, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market benchmark the Straits Times Index (SGX: ^STI) – has inched up by 1.2% over the same period.
The finger of blame
This disparity between the performance of the two shares and the broader market have resulted in some pointing the finger of blame at short-sellers as culprits for the price declines. At first glance, there are merits to the accusations. In an article published in the Straits Times today titled “The long, vice-like arm of short sellers”, renowned financial journalist Goh Eng Yeow wrote that Ezra and Noble are “two of the most heavily shorted firms on the local bourse.” Goh also gave some good statistics on how the percentage of shares out on loan for both Ezra and Noble, “presumably to short-sellers,” had grown markedly over the past year: Ezra’s shares out on loan had grown from 2.9% in July to 11.2% currently. As for Noble, the selfsame figure had ballooned from near-zero to nearly 6% over the same period.
But, I’d like to suggest that it may not be the short-sellers who are causing the price declines. Sure, the short-sellers may have been catalysts for the painful drops, but their actions are a possible manifestation of a bigger issue: Both Noble and Ezra’s business performance have been dreadful over the past six years since 2009.
What makes stocks fall (or rise?)
The legendary investor Peter Lynch once said the following in a rare investing speech(emphasis mine):
“I’m trying to convince people there is a method. There are reasons for stocks to go up. This is very magic: it’s a very magic number, easy to remember. Coca-cola is earning 30 times per share what they did 32 years ago; the stock has gone up 30 fold. Bethlehem Steel is earning less than they did 30 years ago – the stock is half its price 30 years ago.
Stocks are not lottery tickets. There’s a company behind every stock – if the company does well, the stock does well. It’s not that complicated.”
Just as there’s a clear reason for stocks to go up over the long run (when its business does well), there’s also a clear driver for stocks to decline – like Bethlehem Steel showed us, with shrinking profits comes a lower share price.
Ezra and Noble’s corporate history: Falling economics and profits
It’s worth noting that Ezra and Noble’s collapse in their share prices over the past 12 months had happened in the broader backdrop of a sustained decline since 2010. You can see these in the chart below:
Source: S&P Capital IQ
The next two charts you see – Charts 2 and 3 – show you how Ezra and Noble’s returns on equity, leverage (represented by the total debt to equity ratio), and profits have changed since 2009:
Sources: S&P Capital IQ
What we can glean from Charts 2 and 3 are two important pieces of information that suggest why both companies have seen their shares fall steadily since 2010 even as the market has done okay:
The economics of both companies have deteriorated significantly over the past few years as evidenced by how their returns on equity have shrunk even as their leverage has remained high or increased.
Both firms’ profits have been crushed.
Why a collapse can be justified
Short-sellers may at times have nefarious motives; in Noble’s case, research firms have accused the commodities trader of having engaged in questionable accounting practices. If these accusations are not true, then it may not be unreasonable to claim that the research firms are up to some mischief.
But here’s the thing – even if the short-sellers were not present, it’s still a fact that Noble’s shares had fallen by 43% from S$2.10 at the start of 2010 to S$1.205 on 14 February 2015, the day prior to the release of the first of a series of negative reports on Noble by the research firms. And as we’ve seen, there are good possible reasons for the decline given the firm’s uninspiring business results.
In the case of Ezra, there were no accusations of potential wrongdoings being leveled against it. But, it’s easy to see why short-sellers may want to jump on the back of the company.
The sharp decline in the price of oil which had first started in the latter half of 2014 has been a source of woe for Ezra and the firm might deserve some sympathy here given that it has absolutely no control over how the price of oil moves.
But, the firm does have control over issues like its operating costs and the amount of financial risks it’s willing to take. Given what Charts 2 and 3 show, Ezra’s management does not exactly have a good track record in these matters – to that point, the price of oil had remained above US$80 a barrel (it’s around US$60 now) from 2011 to the first half of 2014 and was mostly bouncing around US$100 per barrel, and yet Ezra had seen its profits shrink over that period.
A Fool’s take
When the share prices of companies fall sharply, it’s easy to pin at least part of the blame on short-sellers as they stand to profit when shares fall. But, investors ought to realise that a company’s poor business performance is actually a key driver for any possible declines in its own share price.
In that sense, short-sellers – at least those who are not trying to spread unfounded malicious rumours about a company – aren’t the ones to blame. Instead, companies with poorly run businesses – those who can’t control costs well and yet choose to wantonly assume increasing levels of financial risks – should bear the burden of blame when their share prices nose dive.