Noble Group

Maybank Kim Eng Research, Oct 30

RESUME coverage with a "hold". Our $1.08 target price is based on 0.9 times P/B, which in turn is based on the Gordon Growth model (9.6 per cent FY2014/15 ROE, 10.2 per cent cost of equity, 1 per cent long-term growth rate).

In our view, the recent increase in Noble's share price (+17 per cent in the past three months) has reflected a rebound in BDI, sugar and coal prices, and optimism over its upcoming Q3 2013 results to be released on Nov 12.

That said, the former has some seasonality attributes such as re-stocking by Chinese steelmakers, higher coal demand in the winter and a soaring sugar price due to Brazil fire. In the long term, we are not excited on both volumes and commodity prices.

Noble is reverting to its original "asset-light" business model by refocusing on its role as a supply-chain manager. This should optimise capital utilisation, lifting ROE.

That said, in our view, it will take time for ROE to breach its cost of equity of 10.2 per cent given the earnings headwinds. Management's ROE target of 20 per cent, last seen in FY2008, looks optimistic and is well above our projections of 7-10 per cent over FY2013-15.

Given our assumption of a flattish asset turnover and limited scope for further gearing up of the balance sheet (considering Noble's current high gearing of 95 per cent), 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. A quick and structural margin improvement will thus be hard to come by before FY2015.

Admittedly, valuation looks cheap on a P/B basis. In our view, a "buy" rating is unwarranted as ROE is expected to stay depressed relative to its cost of equity till FY2015. As such, a P/B greater than one time would be too generous.

Upside risks: better-than-expected margin recovery, especially in the agri and metals, minerals and ores sectors.

Downside risks: unexpected trading losses due to excessive commodity price volatility.

HOLD