CHINA’S CREDIT crunch is showing its fangs even on the larger companies.
One of Asia’s leading galvanized steel makers, FerroChina, with a market cap of S$435.8 million and revenues of S$1.2 billion (FY07), is no small player.
Nevertheless, it is one of the first few S-chips that have fallen prey to the current financial markets crisis.
FerroChina halted trading of its shares on Tue this week and announced that it has been unable to repay Rmb 706 million of its overdue working capital loans.
More seriously, it expects to shortly be unable to fulfill further loan obligations amounting to more than Rmb 5 billion.
Its manufacturing operations in Jiangsu have been closed, but the company has sought assistance from local government officials to prevent pre-mature seizure of assets by creditors.
NextInsight ran a story about 2 weeks back explaining 10 tests that alert investors on companies headed for trouble.
Interestingly, FerroChina failed 4 out of the 10 tests ran by JP Morgan, which NextInsight referred to when writing the story.
These are the FOUR:
(1) High gearing, high working capital requirement
Companies with high working capital requirement, low net margin, and high gearing are usually unable to maintain strong growth, especially in today’s deleveraging environment.
JP Morgan highlighted that FerroChina’s net working capital to sales ratio exceeded 20%, that its gearing ratio exceeded 35% and that its net working capital to sales ratio exceeded its net margins by 15%.
(2) Frequent fund raising
FerroChina raised US$130 million by issuing 3-year notes during March to May 2008.
This follows the issue of S$84 million of Redeemable Cumulative Convertible Preference Shares (RCPS) at 70 cents per RCPS in May 2006.
And this in turns follows the company’s May 2005 IPO when it raised S$42 million.
(3) Acquisitions that do not make sense
This test checks for M&A history with little business synergy or are overpriced, especially if a huge sum was paid to its key shareholders or affiliates.
Volume and size of transactions can mask sharp unwarranted jumps in certain accounting items.
FerroChina acquired Superb Team, a sister controlled by its largest shareholder and executive chairman, Mr. She Chun Tai and other insiders via a share swap in October 2007.
Superb Team’s net gearing was as high as 210% as of December 2006.
Nearly 360 million new FerroChina shares, or about 45% of its enlarged capital, were issued to the shareholders of Superb Team, indicating a purchase price at 14.2x FY07 P/E, according to JP Morgan.
29% of the new shares were tradable immediately, 21% tradable within six months, and the rest tradable within 12 months.
This transaction left the company with Rmb 3.8 billion goodwill, or over 60% of its net assets in 2007 that could potentially be written down from the balance sheet in the future.
(4) Hit and run
When a controlling shareholder dilutes its stake to below 50% within just a few years of listing, eyebrows should be raised especially in Asia, where entrepreneurs are highly control conscious.
FerroChina made its first sales of galvanized steel in October 2003. Just 20 months later, the company was listed in Singapore, offering 84 million shares at 50 cents apiece.
Since its IPO, insiders have sold down at least 155 million shares, at an average price of approximately S$1.14 per share, according to JP Morgan.
Founder and former controlling shareholder, Mr. Zhang Yedong, now owns 5.5%. The largest shareholder and executive chairman of the company, Mr. She Chun Tai, holds only 16.3%.
Readers who wish to audit their investment portfolio using the 10 tests, please read NextInsight story S-CHIPS: Warning signs in stock bargain department