Benjamin Graham witnessed how capitalism was hit by the Great Depression. The experience shaped his investment philosophy and thus his investment strategies were ever so gloomy and pessimistic.
Strategies like Net-Net are assuming the companies would go bankrupt and yet, there could be some value to be extracted if the current assets are sizeable.
Fast forward to today, the rate of companies going bankrupt is not as high as it is going to be. Hence, Graham’s Net-Net strategy is not often used as it is harder to find stocks that passes his stringent criteria. However, this does not mean there are no stocks that will pass.
Since Noble Group has been undergoing a lot of fire from Iceberg Research, and her stock price has tumbled, we can apply the Net-Net and see if there is value in the company.
Is Noble Group Undervalued?
Noble Group could be considered a good buy if the current stock price is below two-thirds of the Net Current Assets (Current Assets – Total Liabilities).
From Noble Group’s latest annual report dated 31 Dec 2014,
- Current Assets = US$15,874,125,000
- Total Liabilities = US$11,930,676,000 + US$3,007,719,000 = US$14,938,395,000
- Non-controlling Interests = US$6,864,000
- Perpetual Capital Securities = US$397,547,000
- Number of shares = 6,739,366,962
Net Current Assets per share = $0.10
The calculation shows that Noble Group does not qualify for Net-Net criteria unless the stock price goes below $0.07. There is still a long way down before Noble offers good margin of safety.
Are Noble Group’s Numbers Real And Accurate?
The numbers reported by Noble Group must be accurate for the Net-Net calculation to work. Since the crux of the Iceberg Research’s attack was about the accuracy of Noble Group’s financial reporting, we must dig deeper to evaluate which are the questionable numbers that could affect our Net-Net calculation.
One of Iceberg’s allegation is the overstatement of investment in one of the associates, Yancoal. It is not a concern as the Net-Net calculation has excluded this non-current asset.
However, there are two figures which could make the Net-Net calculation invalid,
1) Cash and Cash Equivalent
Not all the cash reported by Noble will remain as cash. You can refer to Note 22 of the annual report:
“Included in the cash balances with futures brokers is an amount of US$350,408,000 (2013: US$86,408,000) which is not immediately available for use in the Group’s business operations as it is earmarked to cover unrealised losses on futures contracts, and cannot be replaced by alternative collateral arrangements such as stand-by letters of credit.”
Essentially, this is telling me that 39 percent of the reported cash was pledged as margin requirements and may eventually be used to pay for losses in futures contracts, in any.
2) Other Receivables
From Note 24, it was reported that an amount of US$7,380,618,000 was due as profits from futures contracts.
It is common for huge commodities firm like Noble Group to hedge their transactions with futures contracts. But the amount, which accounts for almost half of the current assets is hugely unsettling, with US$7 Billion worth of futures contracts representing one third of Noble Group’s total assets. Iceberg Research commented these mark-to-market futures contracts were worth less than what Noble Group stated. It is better to err on the safe side and assume the value of these futures contracts could not be trusted fully.
To give you a sense of the magnitude of this derivative value, it is suffice to say that without these gains from futures contracts, Noble Group would not have sufficient current assets to cover the total liabilities and hence immediately disqualified as a Net-Net stock.
Benjamin Graham’s Net-Net strategy is a very conservative and useful method to value a company that is facing liquidation threat. This means that this strategy is not useful when the listed companies do not have major issues and are trading at premium stock prices. Sometimes attacks mounted by shareholder activists may rock the stock prices and present a Net-Net opportunity.
The above evaluation shows that Noble Group is not a Net-Net opportunity as of now, and if the two questionable numbers proved to be of no value, Noble Group would never be a Net-Net stock.