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.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
junction's picture

Thanks to Trump, chocolate cake futures are surging.

NugginFuts's picture

Repeat after me: "IT'S THE WORST SINCE LEHMAN!!!!"

Mr.Sono's picture

Turn on the printing press bitchezzzz

Buck Johnson's picture

This is going to end badly.

 

techpriest's picture

It hasn't ended, yet the Chinese are already putting in capital controls and mass (though not universal) passport seizures. They are also looking to turn up the capital controls to a point where it might be tough for Chinese students to attend US universities for lack of funds.

It's getting pretty hot over there already, and all that's left to wait for is open theft. Or for inflation to go to 20+%, which is the other kind of open theft.

divingengineer's picture

Mass passport seizures?
For real?
If that's true I'd be worried.

D Nyle's picture

Blame it on Russia, seems to work for everyone else

PlayMoney's picture

Nothing Xi can't fix with a few trillion Yuan.

Arnold's picture

Outsource printing to Bangladesh for a better unit price.

Lumberjack's picture

From a few years ago...

RUSAL IPO attracts Rothschild and Paulson

http://mobile.reuters.com/article/idUSLNE5BS01920091229

Arnold's picture

Cool.
When does Alcoa report?
Gartman had some sort of Aluminum play going. Maybe it will come into the money.

Tim Knight was also trying to follow the Gartman aluminum trade, without much reported sucess.
But mainly I wanted to see if I could spell aluminum as well as the spel cheker.
Old guy success. but , this no country for old men.

popeye's picture

Where I come from, you missed an "i" ;-)

Midas's picture

British chemist Humphrey Davy named it aluminum in 1812.   Some other British dude claimed that didn't sound "classical" so he renamed it aluminium.   There is no reason for it to sound Latin or "classical" since it isn't a word the Romans used.  Since most Americans couldn't give a shit about putting on airs or accents, we just say aluminum.  We have knocked a whole syllable out for over two hundred years and saved all that time/space at no loss of functionality!   Undoubtedly the other British dude was a complete wanker...

Knob Creek's picture

Kinda like we did with airplane.

johngaltfla's picture

$1296.50 now. And I'm happy for the moment. Too early to take profits but definitely time to hedge against peace. With Pence at the Korean DMZ, nothing will happen tonight.

techpriest's picture

Just watch out for the tungsten-coated aluminum.

Dutti's picture

In fact, it's a good time to take at least partial profits in Gold.

Raffie's picture

So does this effect Kasier Aluminum? If so how?

NurseRatched's picture

Do we really care about this?

So we will all drink beer from glass bottles now. Not a big deal.

Raffie's picture

So aluminum is only used for beer cans is what you are saying?

Ok.................................................

yogibear's picture

ALso used for soda cans but liberals are trying to eliminate soda sales.Taxing at 1.5 or 1 cents per ounce.

Raffie's picture

In a way that is good because of all the damage soda does to you.

http://www.livestrong.com/article/508711-how-can-soda-damage-your-bones/

http://prepareforchange.net/2017/04/14/are-pepsi-coke-more-dangerous-tha...

I love soda, BUT my intake is greatly reduced to like 1 soda a month at best.

Just something to think about.

 

techpriest's picture

99% of my soda consumption is now La Croix or similar, with a little lemon juice.

IOW, no sugar, no sweeteners, just the bubbles. With lemon juice, its great for digestion. Also, if you have a Soda stream or a straight-up soda keg, you can make your own very cheaply.

At this point I can't stand to drink a Coke anymore - way too much sugar.

American Psycho's picture

and your pancreas thanks you for that decision. 

ArthurDaley-OldieTimeTrader's picture

American

I had too many Jack and Cokes back in the day. Now I cycle about 150 miles a week to keep my sugars under control..

HRH Feant's picture
HRH Feant (not verified) techpriest Apr 16, 2017 11:39 PM

I am a sugar snob. If and when I eat sugar I want the real deal: pure cane sugar. I don't want GMO sugar beet sugar or any of the fake sugars. Saw an advert about monk fruit sugar being from a vegetable. What the fuck is cane sugar from? A cow?

Anyhow, it is easy to make a simple syrup with 1 part water to one part sugar, heated. You can infuse that simple syrup with almost anything for flavor. Mint, lemon, and ginger are my favs.

Why would I pay a soda company to melt sugar for me? And to sell me the cheapest sugar possible which is High Fructose GMO Corn syrup. Or even worse. to sell me fucking fake sugar which creates diabetes?

I always have selzer water on hand and I doctor that with the juice / simple syrup of my choice.

If I splurge on pre-made soda it is for a cane sugar root beer or a cane sugar ginger soda, organic, only.

Mr. Universe's picture

Sugar is bad bad bad for you. I love it. Sooooo, the best you can do is make sure that which you do intake is the least damaging.

Ginger syrup is our favorite because I can convince myself it's good for arthritis. Add in a wedge of lime and wow, the best.

Fresh fruit works well and is a better sugar, provided you don't add more cane. Still I admit that Jackson Hole Soda "Snake River Sarsaparilla"  is the Bee's knees.

garypaul's picture

chemistry 101: refined white sugar (pure sucrose) is the same regardless whether it is extracted from cane, beets, or even GMO beets.

Mr. Universe's picture

Real life 101: Nothing works out as in a laboratory. The chances of finding "pure" surcrose in any product is questionable, especially in GMO products.

garypaul's picture

So wouldn't that include your so-called cane sugar?

Wow are you sad. I meant "pure" as in mostly/essentially. If beet, cane and GMO sugar are all 99.99% sucrose, that's basically pure.

Good God the level of ignorance on this site. I'm done.

FoggyWorld's picture

Think that it is the bubbles that do some serious damage.   Read about it recently and is making me rethink.

mc225's picture

i get a 'pop' effect with water/lemon/sugar or honey, then with chili pepper. ymmv

ReasonForLife's picture

Apple needs to switch to Tin for their casings so that their customers maintain the product value.  And when the Greatest Depression Hits, they can specialize in E-Sardines as well where you pretend you own/eat it.

Anteater's picture

Fossil relic.

Alcoa makes ingots. Metal manufacturers make, stock and distribute shapes.

PPG makes thermal windows, lots of them, with extruded aluminum.

There is a global highrise condo boom.

Will the pending collapse of the world's largest ingot maker be the wooden stake in the real estate bubble?

Or, will the collapse dump inventory at firesale prices on the market, a huge windfall to the window makers?

Or will there be a headfake short opportunity on the news, then massive short squeeze, then vapor top death-spiral?

Nobody sane gives a rip about fiat gold toilet paper.

CPL's picture

And it'll fall to 1200 as usual, they won't ever let you get your money back I hope you understand that's how it's been hardwired now.  You will never see much out of your investment except in playing a super risky options writing practice.

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.