QA with Noble Group

Date: September 8, 2015

In this edition of our e-newsletter, SIAS talks to Noble Group about the company’s business model and strategy, as well as recent initiatives to increase transparency that included a PwC review and an Investor Day event.

SIAS – Can you help our readers better understand about Noble Group. What is it exactly that you do?

A. Noble Group is one of the world’s largest commodities trading firms. As a leading supply chain manager, we buy physical commodities and blend and adjust them into customised, consumable products that meet the requirements of our customers.

Our core strategy is to be the best company in the world at moving the physical commodity from the producer to the consumer and managing the market, credit and operational risk associated with this.

To focus more clearly on our core competency – moving the physical commodity – we have reverted to a higher-return, lower-risk “asset-light” business model. In order to achieve that we have reduced our ownership of industrial assets such as sugar mills, crush plants and coal mines. This has reduced fixed assets from USD 2.9 billion at the end of 2013 (15% of total assets) to less than USD 900 million today (4% of total assets).

In focusing on an asset-light model, we recognize that our expertise lies in managing supply chains and the associated risk, while other companies have expertise in mining or oil and gas exploration.

We aim to partner, and complement, industry leaders in these allied production and consumption industries, allowing them to focus on their area of excellence while we manage the delivery of their products to our customers. Investing in partners limits our financial exposure, allows us to focus on our core competency of providing supply chain services, and secures us access to the key products we trade.

Our business is now separated into four segments – Energy (Oil Liquids and Energy Coal), Gas and Power (North America Energy Solutions and Gas & Power), Metals and Mining (Metals and Carbon Steel Materials) and Corporate (Logistics, Origination and Associates).

Under our Associates division we retain a 49% stake in Noble Agri, our agricultural partnership with COFCO, after selling 51% in 2014 resulting in a cash inflow of USD 3.3 billion. This followed the receipt of some USD 800 million in 2012 from the merger of our coal assets into Yancoal.

In addition, in the last two years we have partnered with new businesses such as X2 Resources and EIG in Harbour Energy. Both are cash rich start-ups, with industry leading management with proven track records backed by leading global investors. They have over USD 10 billion available to invest in producing assets, at what may well prove to be the
bottom of the cycle.

Noble has associate level interests in these businesses and is the preferred marketing partner for both. We will purchase their output, managing the supply chains, and delivering the products to customers.

This asset-light strategy has allowed us to diversify our business model and products. Five years ago, Noble’s business could be broadly categorised as a big-bulk commodities business. But, from negligible levels at the start of the decade, in the last twelve months our Oil Liquids, Gas and Power businesses have contributed 60 per cent of operating income from supply chains.

Noble has also diversified geographically, with North America growing from 12% of our volumes to 32%, and reliance on China reduced from 42% to 30% of our volumes, in just three years. In particular the operating income contribution from North America Energy Solutions, our U.S. power retailing business which was purchased in 2010, has grown to 18% in 1H2015.

This has all resulted in volumes growing strongly, up 40% year on year in 2015, leading to robust profits across our core businesses.

SIAS – How does Noble create value as a physical merchant?

A. We do it in several ways:
We source commodities from producers in low-cost regions.

2) We provide value-added services, blending and adjusting product specifications to ensure optimal mix and qualities. They include: 

3) We deliver products to our network of customers across the globe.

SIAS – What is Noble doing to improve transparency? Can you elaborate on these initiatives?

A. Starting with our 1Q2015 results announcement in May, we have integrated some of the disclosure protocols for quarterly unaudited results that were only previously in our annual report. We have also expanded our quarterly Management Discussion and Analysis commentary five-fold, with the latest report posted on SGX consisting of more than 8,500 words.

In addition, we have adopted EBIT level segmental profit and loss disclosure and split our businesses (Energy, Gas and Power, Metals and Mining, Corporate) into four segments, instead of the previous two. During our 2Q2015 results, we released more information on Yancoal’s valuation, and provided background on the Gloucester Coal merger. These associates and investments are key to our asset-light strategy and increased understanding of them will help investors see the strategic role they play in growing Noble’s businesses.

We have also disclosed movement in Net Fair Value gains and losses, especially for Level 3 balances that make up only 7% of Noble’s total assets. This is because Level 3 represents valuation techniques where one or more inputs that affect the fair value measurement are unobservable.

To further assure investors of the robustness of our fair value measurement, we commissioned PricewaterhouseCoopers to evaluate how the Group values certain long-term physical commodity contracts as at 30 June 2015. The contracts reviewed represented 81% of the value of derivative contracts with a duration of at least two years and 98% of the value of the Level 3 net assets. This was performed in accordance with the Singapore Standard on Assurance Engagement 3000. We released the full version of the PwC review, not a redacted version, nor an abridged summary.

We also recently held an Investor Day that was probably unprecedented for a listed company because it had no restrictions on attendance (400 shareholders and members of the public in the audience, with over 1,000 online via a live webcast) and included a two hour question-and-answer session where every question asked was answered in full by management. Following that we posted a 136-page Investor Day presentation deck on our website, as well as the transcript of the question-and-answer session and a video clip of the presentation. The Investor Day was offered as a supplement to our usual quarterly earnings calls, which, since 2007, have allowed unrestricted toll-free access to any participant, with full transcripts posted on our website.  

The positive results of our increased transparency efforts are becoming evident, as highlighted in a recent article in CFO Innovation Asia.

SIAS – Can you elaborate more on the processes and findings of the PwC review?

A. The process was overseen by a Board Committee that comprised our newest independent board directors, led by Paul Brough who was the Senior Partner of KPMG in Hong Kong. Management was not involved in the process.

PwC’s review examined the governance, organisation and policies that govern the Mark-to-Market (MTM) valuation models, while also examining the contracts themselves. For each counterparty contract reviewed, PwC also obtained the detailed valuation model and checked the application of the Relevant Criteria1 to the construction of the model. This included an examination of all the inputs (such as volume, price, discount rates and reserves), as well as the construction of the model itself. PwC supplemented this with detailed discussions with the various teams that play a role in this process.

Overall, PwC concluded that Noble has adopted an approach to valuations that is consistent with the Relevant Criteria, in all material respects. Indeed, in some aspects of the model construction (such as the development of discount rates and development of counterparty credit risk curves), Noble has an approach which is more sophisticated than that of many non-financial companies. PwC also noted a strong segregation of duties between the different teams that provide key inputs into the models.

PwC highlighted certain recommendations to strengthen Noble’s fair value policies and procedures, although none of these have affected the overall opinion. The Board is implementing these recommendations immediately to ensure the company remains a leader in the industry where our MTM valuations are concerned.

SIAS – Given the challenging environment that the company and the sector is in, what is Noble’s strategy going forward?

A. The last six years have been a very challenging environment for all commodities players. And after the issues and distractions of the last six months, the management team of Noble is firmly focused on running the business to provide compelling results and returns for our shareholders.

Over the past few years, Noble has deliberately repositioned the company. Our asset-light strategy has generated diversity, volume growth and core income running at US$600 million. Due to reduced capital expenditures and long-term assets, we are also lowering our funding costs by reducing long-term funding.

This enables our balance sheet to be further strengthened. We will continue to have a healthy balance sheet and the necessary liquidity to fund our business under all circumstances, especially in the toughest of times. Our debt to capitalisation has reverted to historically normal operational gearing levels, and we had an infusion of $3.3 billion of cash from the sale of 51% of our stake in Noble Agri. Our net debt after adjusting for readily marketable inventories stands at US$2 billion, as at 30 June 2015.

On the foundation of our strong balance sheet, the Group will have the flexibility to explore all available options. We will continue our asset-light strategy and work with producers, consumers and partners to be the best physical merchant in the world at moving commodity products.

Relevant Criteria represent those factors which are necessary for management to ensure that the MTM valuations are derived in a manner which is in compliance with the relevant requirements of IFRS13 as well as standard industry practices. The full list is included in the
report, which is posted on Noble’s website.