Commodities

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Investors, and the media, have been so focused on the accounting of Noble Group that they’re missing the trouble facing the company -- which, by the way, is clearly stated in its books. The commodities trader is seeing its margins shrink as the prices of the products it sells drop. 

The Hong Kong-headquartered group moved 205.8 million tons of various commodities and earned revenue of $53.7 billion in the nine months ended Sept. 30, its third-quarter report shows. That's an almost 44 percent increase in volumes and a 17 percent decrease in the amount of money its sales generated. In the same period, Noble generated operating income of $3.74 per ton, less than half what it did a year earlier.

On the Increase
The amount of short-term financing Noble uses for every dollar of income is growing fast
Source: Company accounts
December 2014 figures reflect full-year numbers because Noble didn't report profits for the quarter
Rising Liabilities
As commodity prices drop, Noble has been taking on more loans to fund its everyday business
Source: Financial accounts

That shouldn’t come as a surprise. The commodities Noble sells are costing a lot less, which means it needs to move more of them around to make the same amount of money. And while its gross margins are increasing, higher volumes entail more transportation and administrative costs, and these things add up.

It tends to show in how much Noble Group has tied up in working capital. As at Sept. 30, the company had $198 in working capital for every dollar it earned in the third quarter. That compares with $46 just six months earlier.

Noble has been mitigating this effect by managing its working capital better, making sure, for one, it gets paid faster, which is known in accounting speak as reducing trade receivables. Yet to fund the increased volumes, Noble is adding on the liability side. Its short-term bank borrowings increased to $2.51 billion as of Sept. 30, from $440.1 million at the end of 2014.

Considering Noble’s credit-default swaps are the most expensive in Asia, it's fair to assume that borrowing money will get more expensive for the company, and that could eat further into margins.

Pretty Pricey
The cost to insure Noble Group's debt against nonpayment is among the most expensive in Asia
Source: Bloomberg

Then there are the perils of being a middleman when the market is in free-fall. Buyers have more bargaining power and sellers can’t squeeze much further without going bust. And when Noble's suppliers go bankrupt, that equates to a loss, since these companies would probably default on their delivery contracts.

To be fair, Noble Group isn't alone in its malaise. Trafigura Beheer said in December that its trading volumes had increased 17 percent for the year ended Sept. 30 while its revenues dropped 23 percent. It led Chief Executive Officer Jeremy Weir to warn in his letter to shareholders in Trafigura’s annual report that: ``Commodities trading will in future be a business for large firms with diversified and well-financed trading interests or for small specialists. It will certainly not be a hospitable environment for mid-sized, under-capitalised or unfocused players.''

Whether Noble will find itself in that large and well-financed bracket will become clearer after it refinances some $2.1 billion of loans due in April and May. Or perhaps Chairman Richard Elman has already come to terms with the idea that the company he founded will migrate toward the latter category. Noble has already jettisoned its money-losing agri business and scaled back some of its mining operations. And Elman did, after all, tell Reuters last month that he sees Noble's future as a smaller, more nimble group.

If that’s the case, then Noble would do well to stop trying to trade greater amounts at every opportunity and instead sharpen its focus. Making money from commodities is an ever-tougher gig and these days, selling smarter counts for more than sheer scale.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net