World's Biggest Aluminum Producer Faces Default, Warns Of "Dramatic Social Unrest" Without A Beijing Bailout

Tyler Durden's picture

Step aside China Huishan Dairy Holdings - China's largest dairy producer which cratered last month after a negative Muddy Waters research report brought attention to a company we knew for one year was collateralizing its cows to fund stock buybacks - and make way for what may be the next Chinese megafraud.

While China Hongqiao Group may be best known for being the world's largest aluminum producer, it has in recent months featured just as prominently among short-seller reports who have accused the company of being a fraud. As the WSJ's Scott Patterson writes, questions about China Hongqiao’s finances first emerged in November, when an anonymous short seller wrote on a website called Hongqiao Exposed that the company’s profits are “too good to be true.” China Hongqiao in the March 31 statement called the report “untrue and unfounded.”

A subsequent 46-page report on Feb. 28 by Emerson Analytics, a trading firm focused on Chinese stock-market fraud, disclosed more allegations of fraud involving the Chinese commodity giant.

Emerson accused China Hongqiao of “abnormally high” profits generated by underreporting production costs and disclosing electricity expenses—one of the biggest costs for aluminum producers—as much as 40% below their true cost. Emerson said it investigated Chinese electricity costs, spoke to former China Hongqiao employees and compared the company’s costs and profits with other comparable companies.

Additionally, China Hongqiao has been more profitable than some Chinese competitors. For instance, China Hongqiao earned an average operating profit margin of 27% in the past five years, compared with minus-1.7% for state-owned Aluminum Corp. of China , known as Chalco, and 5.9% for Alcoa, according to FactSet. “People were always skeptical about how they managed to be more profitable than their peers,” said Sandra Chow, a credit analyst at CreditSights.

And while China Hongqiao denied the Emerson report’s allegations and said it hired an investigative agency to look into the firm and people behind the claims, things are starting to unravel rapidly for the Chinese megacap.

As Patterson reports, China Hongqiao - the world’s biggest aluminum producer - is in trouble, locked in a feud with its accountant over fraud allegations that have forced it to suspend trading of its shares and seek help from the central government in Beijing.

Just like in the case of its cow dairy peer, the problems emerged to the surface following the bearish 3rd party reports. Just days after the Emerson Analytics note, on March 4 China Hongqiao sought assistance from a trade group, the Chinese Non-Ferrous Metals Industry Association, or CNIA, saying the short sellers’ claims of inflated profits were forcing the company’s accountant, Ernst & Young, “to adopt an extremely conservative and careful attitude.” One wonders just whose books E&Y had been reviewing until that point if it took an outside party to bring attention to potential fraud at one of its biggest Chinese clients.

From that point, it all just spiralled out of control: on March 6, Ernst & Young notified the company it had suspended its audit of its 2016 financial results, according to a March 31 statement by China Hongqiao. Ernst & Young asked the company to commission an independent investigation into the short sellers’ claims, delaying the release of the company’s annual financial results, China Hongqiao said.

With E&Y washing its hands of China Hongqiao, and without audited results, China Hongqiao said in its letter to CNIA, the company risks an investigation from Hong Kong securities regulators and a credit crunch. According to the WSJ, the company has about $10 billion in debt and could be in default on a $700 million loan unless it gets waivers from creditors, says Standard & Poor’s Global Ratings. S&P, citing the move by Ernst & Young, has downgraded China Hongqiao’s bonds a notch deeper into junk territory to B-plus. Once again, one wonders just who both E&Y and S&P were analyzing until the emergence of the short seller's report.

To be sure, in its March 31 statement, China Hongqiao denied the short sellers’ fraud allegations, calling them “untrue and unfounded.” Ernst & Young declined to comment, but by then the market had largely smelled a rat, prompting China Hongqiao to demand both the CNIA and the Chinese government to come to its aid, warning in its March 4 letter of “serious effects” if nothing is done, including “regional systemic financial risks” and “dramatic social unrest.”

Ah yes, playing the usual assured destruction card if nothing is done card. Only in this case, the megafraud, pardon aluminum producer may have a point. You see, over the past few years,  China Hongqiao drew the attention of the global aluminum market and U.S. trade officials as it soared to the pinnacle of the industry leapfrogging the production of giant competitors like Alcoa in the U.S. and United Co. Rusal PLC in Russia.

As Patterson, who has been closely following the aluminum space for years notes, the rise coincided with American allegations that Chinese companies—helped by government subsidies—flooded the world with cheap aluminum, coal and steel, depressed prices and decimated U.S. industries. U.S.-Chinese trade issues were a focus of a two-day summit last week between President Donald Trump and President Xi Jinping of China.

The problem, now that the Company's fraud appears to have been exposed, is that China Hongqiao, a Hong Kong-listed company, employs no less than 60,000 people. A sudden collapse may indeed result in "dramatic social unrest"

There is a silver lining: as the WSJ adds, "trouble for Hongqiao could upend the aluminum industry in China and present an opportunity for American producers who say the company has been using unfair tactics to dominate the industry. It could also reinforce the broader concerns over what many view as questionable business practices by China’s big industrial giants, many of which are increasingly active on the global stage."

* * *

Perhaps the best news from this event, should it indeed result in the insolvency of China Hongqiao, is that one of the biggest commodity zombie companies will soon be wiped out, allow competitors to take its place.

Some statistics:

China’s aluminum output reached an estimated 31 million tons in 2016, according to the U.S. Geological Survey, more than half of global output and up 60% since 2011. That is the year China Hongqiao went public, raising $817 million. China Hongqiao’s founder, Zhang Shiping, holds an 81% stake in the company worth $5.3 billion, according to FactSet.

 

The U.S. government in January launched a formal complaint against the Chinese government with the World Trade Organization, accusing China of funneling artificially cheap loans from state-run banks to aluminum producers including China Hongqiao. China provides China Hongqiao with access to cheap coal, aluminum and electricity, according to the WTO complaint. The dispute shines a light on the underpinning of a Chinese aluminum boom that has roiled trade relations with the U.S.

 

China Hongqiao’s production capacity has almost quadrupled to 6.7 million metric tons since 2011, according to commodity researcher CRU Group. Rusal can produce 4.1 million tons of aluminum a year, Alcoa up to 3.4 million tons of aluminum a year, CRU says.

For now, it isn’t clear if the government or regulators will step in. According to the WSJ, the CNIA, the Hong Kong Securities and Futures Commission, and China’s Ministry of Industry and Information Technology, which oversees China’s industrial policies, didn’t respond to requests for comment.

The events are “very embarrassing for the Chinese and for Hongqiao,” said Paul Adkins, managing director of AZ China Ltd., a Hong Kong consultancy that tracks the Chinese aluminum industry.

Since this is just the tip of the iceberg for China's "walking dead" commodity companies, Beijing has an option: proceed with even more bailouts, or prepare for much more embarrassment in the coming months as the veil is lifted and China's commodity zombies - first profiled here in October 2015 - are exposed for the entire world to see.

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bruno_the's picture

Less chemtrails?

knukles's picture

Unfortunately, not.
Big Weather is your new MIC

directaction's picture

Please market, crash.
The freeways are too crowded

GunnerySgtHartman's picture

Swan dives from 50-story office buildings in Manhattan may pick up.

directaction's picture

I wish.
The rent is too damn high. 

HRH Feant's picture
HRH Feant (not verified) Apr 16, 2017 8:39 PM

US bond futures are going lower. Silver and gold are moving higher.

BTC falling.

I love watching Bloomberg with the Asian market opening on Sunday afternoon!

Oh, I forgot, Boomerpoop doesn't mention BTC price. Go figure: $1177.40 and falling.

NugginFuts's picture

How much you wanna bet the whole thing boomerangs by NY opening bell?

I'd LOOOOOOOVE the correction to start and my phyzzz stackz to skyrocket, but there's this lingering doubt that TPTB are ready to let it all hit the fan just yet.

Trump will announce peace with NK, say "Ooops, my bad in Syria. Darn MIC. I knew it the whole time", and then follow that up with "The dollar isn't strong enough yet... we need more bigly stimulus" and just like that it'll all turn around before breakfast. 

HRH Feant's picture
HRH Feant (not verified) NugginFuts Apr 16, 2017 9:38 PM

They usually take out the PM hammer between midnight and 3:00 am EST.

I want to learn how to read the BTC outflows and inflows. Weird considering what has been happening in Asia that it remained steady.

Navymugsy's picture

Alcoa does nothing but lie anyway. They only make money on paper using Non-GAAP gimmickery.

techpriest's picture

You figure we'll find out about the tungsten-coated aluminum being passed off as real tungsten?

uhland62's picture

Or tungsten covered 'gold' bars? 

techpriest's picture

Yes, I was playing on the gold-coated tungsten. In this case they might have to skimp on the tungsten too.

AustrianJim's picture

Should drive Snapchat to $140.

short screwed's picture

I'm just glad this sort of thing can't happen here in the USA.

/sarc

RagnarDanneskjold's picture

Hongqiao's strategy is to accuse the Chinese government of being unpatriotic if it allows the company to be destroyed by an American-led attack by Western aluminum companies. 

 

World's Largest Aluminum Producer Appeals to Patriotism Amid Fraud Accusations

It is noteworthy that the association will Weiqiao Group repeatedly suffered short selling to "the United States led the Western countries to contain China's aluminum industry." Association since 2001, China has more than the United States, Germany has become the world's largest producer of electrolytic aluminum, the world's largest consumer of electrolytic aluminum, the world's largest export of aluminum exports. These Western countries, led by the United States, have never stopped suppressing and accusing China's aluminum industry.

NurseRatched's picture

"I'm just glad this sort of thing can't happen here in the USA"

In the USA, Ernst & Young would have caught this thing 5 years ago when a college intern would point out "Hey boss, a 27% Operating Margin for a commodity company is bullshit."

Giant Meteor's picture

The fundementals of the e con o me are strong !

GaryInTexas's picture

Can't happen here. China cratered our aluminum manufacturing years ago. Maybe we can ramp it up now.

sinbad2's picture

There really isn't the demand. The US consumes 12% of global aluminium, China 48%.

Able Ape's picture

With 8 billion people in the world how can you mess up aluminum production?...Cheating?...

Giant Meteor's picture

One wonders just whose books E&Y had been reviewing until that point if it took an outside party to bring attention to potential fraud at one of its biggest Chinese clients.

Creative accounting.

It ain't about the product, it's all about the skim ...

silverer's picture

Balk at bauxite. Might as well.

wwxx's picture

I'm surprized the article didn't mention the new Beijing-Moscow central bank/clearing house, and if the Americans have been any example at all in the past...[2007-8 crash]...shouldn't there be an op-ed conclusion about the world's largest, rumors of fraud, dramatic 'ratings changed' and of course the fear of 60,000 jobs being wiped out-- being correlated to the new clearing house?

 

I'm sure Helicopter Ben would start out with some sort of 'stress test' or other fundamental excuse from the roulette of excuses, yanno to justify a huge bail-out or whatever they might call it, with the new gold-backed currency.  There should be no doubt that heavy industries will have to buy-in, and it seems the Author Andersons, ummm ERnst & youngs know just how to cook the books to bring said buy-in about, not withstanding a bit of FAKE PROPAGANDA, news releases to help grease the new CB wheels.  After all, the new gold-backed currency is ONLY for the commercial markets, or haven't you heard?  If you haven't heard, you need only look at the American set-up from 8or 9 yrs. ago, there was nothing but nothing transmitted to mainstreet, except the doom & gloom, and some low interest rates.

 

wwxx

 

BTW, my tin foil hat really is aluminum, of which I wear while looking for any extra bales/pallets of gold-backed yuan, laying around yanno.

 

uhland62's picture

The problems with the aluminum bank are older than the Moscow/Beijing clearing house bank. 

Goldman & Sachs had an aluminum issue about 8/9 years ago. Could be just flow on.

Joebloinvestor's picture

So cooperation with the US against North Korea is a diversion?

wwxx's picture

joebloinvester

 

Absolutely, more FAKE PROPAGANDA, media hype, gawwwwwd even the 'instant replay' is a joke, nothing more than the same 'oops, rocket fell over on the pad' warmongering that was perpetrated 10 or so years ago, hundreds of thousands of troops, parades...bla, bla, bla.  Same shit different decade, amounts to nothing more than a FAKE tweetdistraction.

 

wwxx

TheLastTrump's picture

Take note, China is afraid of losing cuntrol of its country due to lack of work. Guess who got a cold shower in 2008 ff.

techpriest's picture

In China's case, they don't have the money for a social safety net for so many people. So, loss of jobs = immediate loss of standard of living = immediate anger.

Radical Marijuana's picture

Kick the aluminum can on down the road ...

DFCtomm's picture

They'll get the bailout from the Chinese government, so what's the difference between China and the U.S.? The difference is that the Chinese government will kill all the exectuvies responsible if they haven't fled already, but in the U.S. they would have received a bonus.

Wahooo's picture

World's got plenty of alunimum, so let er fail.

silverer's picture

Oops. UP goes the price of Ford pickups.

DaBears's picture

It's okay they are hedged by trillions worth of empty apartments valued at @ 70:1 income to price, PROFIT! All is well move along.

whatamaroon's picture

Why do I think a well placed MOAB will fix everything?

orangegeek's picture

same old chi-coms

Ben A Drill's picture

It's my fault. I used to drink beer in aluminum cans, now I drink beer in glass bottles.

Benito_Camela's picture

Nobody too big to jair. Thlow dem chinks in da clink. 

pparalegal's picture

Where does Ford get their stuff for that new F150 ecobox truck?

just the tip's picture

losing 60K jobs in a country of how many.  no worries.  more and cheaper labor for the competitors.  let it fail and erase the debt.  one of the princelings will re-open it, with an off the books loan.  problems solved.

dunce's picture

The USA subsidized aluminum production for many years by building huge dams on the taxpayers dime to provide cheap electricity to our producers.  Could obama's war on coal made it cheap enough to give chinese producers an advantage? I suspect domestic demand growth and private utility complaints have forced our hydro rates up.

truthalwayswinsout's picture

This is the MOTHER OF ALL BOMBS (MOAB.  There are over 1000 companies in China with overcapacity, and fraudulent balance sheets with a total value equal to over $4 Trillion. They are all on the verge of bankruptcy.  They have been bankrupt for the past 2-3 years but it has all been hidden. Hence the MOTHER OF ALL LIES (MOAL)

When this baby blows, and it is getting closer as currency exchange is vastly negative for all the individual rats leaving the ship, it will be 3-4 times worse than the Great Depression.

 

Last of the Middle Class's picture

Holy shit, do these dumb shits not get what QE is for? To bail out overleveraged, debt ridden, poorly managed, massive corporations at the expense of the rest of society. I mean damn, guys wake the fuck up.

aloha_snakbar's picture

Too big to foil...

robertocarlos's picture

Opps, sorry. We should have ended this thread on your post.

robertocarlos's picture

It is ALUMINIUM. Why can't you get it right?