Noble Group Limited and the Short Sellers: My Thoughts – Part 1

Is Singapore’s stock market turning into a play-ground for short sellers? That’s a worry that some investors have in their minds, judging by a reader-penned letter titled “Don’t let S’pore be playground for short-sellers” that was published in The Straits Times yesterday morning.

The letter cited commodities trader Noble Group Limited (SGX: N21), whose “share price has fallen by 40 per cent since being attacked by Iceberg Research in February,” as an example of the damage to the stock market that can be wrought by short sellers.

There are plenty of talking points in the letter worth discussing, so for the sake of brevity, I’d be breaking up my discussion into two articles.

This article’s the first and it’d be about how those who think that Noble’s a poster child for all that’s wrong about what short sellers are doing are actually missing an important point here.

Plotting the descent

On 15 February 2015, Iceberg Research, a little-known research outfit which Noble claims was started by a disgruntled ex-employee, released the first of its three research reports which were highly critical of Noble’s accounting practices, amongst other issues.

This presumably started a reaction in the market, with Noble’s shares falling, as alluded to earlier, by a total of 43% from S$1.205 on 14 February 2015 to S$0.685 currently.

Following Iceberg Research’s attack, two other notable critics of Noble – namely the investment firm Muddy Waters (Muddy Waters released its own report on Noble in April and stated that it was shorting the company’s shares) and ex-investment banker Michael Dee – also emerged, heaping more pressure on the commodities trader.

The cause for the descent

Given the sequence of events, it’s easy to pin the blame for Noble’s woes solely on the firm’s critics.

But, there’s something worth noting here. Noble’s shares had already been on a steady decline since the start of 2010 when they were exchanging hands for S$2.10 apiece; Noble’s price on 14 February 2015 thus represented a 43% decline from where it was back then. That had happened even as the Straits Times Index (SGX: ^STI), Singapore’s market barometer, had generated returns of 18% over the same period.

From 2009 to 2014, Noble had turned in a horrible corporate performance: Its profits crashed, its returns on assets sank, and its returns on equity had collapsed even while its leverage remained high. You can see all these in the table below:

Noble's financials

Source: S&P Capital IQ

If we keep in mind the maxim that the stock price of a company tags along with the performance of its business over the long-term, then it wouldn’t be unreasonable at all to conclude that Noble’s dreadful price decline from the start of 2010 to 14 February 2015 had largely been due to its equally-dreadful business results.

This brings me to the important point that those who think Noble’s painful experience since February this year had been due nearly exclusively to the involvement of short-sellers might be missing: Noble wasn’t exactly a cheap share back on 14 February 2015 given its prior lousy business results and a continuation of that alone could have caused the company’s stock price to fall too.

At a price of S$1.205 on that fateful day, Noble was selling for 13 times its trailing earnings and 1.1 times its book value. That looks ostensibly reasonable, if not cheap. But we have to take into account how Noble’s returns on assets and returns on equity have shrunk to the low single-digits over the years (see table above) – with that in mind, it can be reasonably argued that Noble’s shares were not cheap.

That’s especially so when we consider that the Straits Times Index, with constituents that have much better fundamentals than Noble, had a price-to-earnings and price-to-book ratio that was in the neighbourhood of 14 and 1.3 respectively at that time.

It’s all just a theoretical exercise on my part, but if Noble’s business were to continue languishing in the future the way it had over the past few years, its share price may still just be on a slippery downwards slope from 14 February 2015 onwards even without the appearance of Iceberg Research, Muddy Waters, or even Michael Dee.

Noble had announced two sets of quarterly earnings (for the fourth-quarter of 2014 and first-quarter of 2015) since the release of Iceberg Research’s first report. Both sets of earnings were anything but healthy; the fourth-quarter earnings saw Noble clock a quarterly loss for the first time in three years while the first-quarter earnings had the firm’s revenue and profit for the quarter suffer year over year declines of 7% and 30% respectively.

It would be really interesting to see how Noble’s share price would have reacted to the two earnings releases in the absence of its three high-profile critics; unfortunately, this is an experiment that we’d never get to conduct.

The important point

Noble’s critics may have caused some confusion and panic in the markets when they started openly criticizing the company. If their accusations end up being false, then they would be deplorable. Noble has recently commissioned a review of certain aspects of its business that had been under heavy criticism and we’d soon know if the company’s critics had been right or wrong.

But whatever the outcome of the review is, given what we’ve seen above about Noble and its business, I don’t think it may be fair to pin the blame for Noble’s sharp price declines these past few months solely on the short sellers. The company’s own poor business results likely have a significant role to play too. This is an important point that investors have to note – it’s not always the short sellers who are the villains.

This is where I’d end the first article. In the next piece, I’d be discussing the role of short sellers and why they should not be categorically vilified. Hit this link and it’d take you there.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.