Can Noble Group Limited Bounce Back After 5 Years Of Pain?

Amongst the 30 blue chip stocks that make up Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI), commodities trader Noble Group Limited (SGX: N21) has been the worst performing company over the past five years since 23 December 2010.

In that time frame, Noble’s shares have lost 78% of their value whereas the Straits Times Index has declined by a ‘mere’ 8.7%.

After years of pain, would there be better days ahead for Noble Group’s long time investors? The answer to the question would depend largely on the company’s long-term business performance in the future. And unfortunately, there may be signs that point to Noble Group having a low quality business under its belt.

An authority on quality

Billionaire investor Warren Buffett is someone investors may want to listen to when it comes to assessing the quality of a business.

Having been chairman of the U.S.-based Berkshire Hathaway Inc since 1965, Buffett has led the firm’s book value per share – a good proxy for the company’s intrinsic economic worth – to grow at an astounding compound annual rate of nearly 20% over the past fifty years. And, Buffett had accomplished the feat mainly through smart acquisitions of companies and astute investments in stocks.

In his 2014 Berkshire shareholder’s letter, Buffett had listed six criteria that a business needs to meet in order for him to consider it as a potential acquisition target. They are:

“(1) Large purchases (at least [US]$75 million of pre-tax earnings unless the business will fit into one of our existing units.),

(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),

(3) Businesses earning good returns on equity while employing little or no debt,

(4) Management in place (we can’t supply it),

(5) Simple businesses (if there’s lots of technology, we won’t understand it),

(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).”

As stocks essentially represent partial ownership of a business, Buffett’s acquisition criteria for private businesses can also be useful when it comes to stock market investing. But, it’s worth noting that not all of Buffett’s six criteria are applicable. In fact, criteria (1), (4), (5), and (6) could be skipped by most stock market investors.

That’s because most individual investors are not limited by a company’s size (Buffett needs big acquisition targets in order to move the needle for the US$330 billion Berkshire). Meanwhile, publicly-listed companies will also have management teams already in place and have a stock price that’s refreshed all the time. Coming to criterion (5), it is merely a reflection of Buffett’s own analytical strengths and weaknesses.

So with that, let’s see how Noble Group fares against the two remaining filters in Buffett’s test.

Falling short in quality

The graph below, Chart 1, illustrates the changes in Noble’s revenue and profit over the past decade from 2004 to 2014.

Chart 1 - Noble's revenue and profit
Source: S&P Capital IQ

While the company had enjoyed striking and consistent revenue growth over the period under study (the top-line had jumped by nearly 10-fold from US$8.62 billion to US$85.8 billion), the same can’t be said for its profits, which had shrank by more than half from US$289 million to US$132 million.

Let’s turn our attention to Noble’s returns on equity now. Chart 2, which you can see just below, plots out the commodities trader’s returns on equity as well as net-debt (total borrowings minus cash) to equity ratio over the same timeframe as Chart 1.

Chart 2 - Noble's returns on equity and net debt to equity ratio
Source: S&P Capital IQ

Noble has at times managed to generate a healthy return on equity of more than 15%. But, the company had done so via the use of lots of debt, as seen in how its net-debt to equity ratio had been above 70% in many of the years we’re looking at. Also, Noble’s returns on equity have fallen to pitiful single-digit levels in recent years, coming in at just 4.2% in 2014 despite having a rather high net-debt to equity ratio of 47%.

A Fool’s take

Given what we’ve seen – the falling profits and poor returns on equity despite the use of high amounts of debt – it is likely that Noble would look like a very unattractive business in the eyes of Buffett.

That being said, it is worth noting that all the numbers above are backward-looking. As such, it is possible that Noble could post much better business results in the years ahead if management can turn things around. But, in the here and now, I think it is fair to say that Noble has a low quality business and that’s a risk that prospective and current investors of the company may want to be aware of.

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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 owns shares in Berkshire Hathaway.