Chinese Aluminum Giant Faces Credit Crunch

China Hongqiao says fraud allegations threaten its financial stability

The China Hongqiao factory in Zouping, China

The China Hongqiao factory in Zouping, China PHOTO: BRENT LEWIN/BLOOMBERG

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.

China Hongqiao Group Ltd., has drawn the attention of the global aluminum market and U.S. trade officials as it soared to the pinnacle of the industry in the past few years, leapfrogging the production of giant competitors like Alcoa in the U.S. and United Co. Rusal 0486 -2.79% PLC in Russia.

Its 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.

Now China Hongqiao, a Hong Kong-listed company that employs nearly 60,000 people, is facing fraud allegations from two short sellers that the firm says threaten its financial stability.

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.

China Hongqiao declined to comment for this article.

In a March 4 letter reviewed by The Wall Street Journal, 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.”

Then, 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.

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. The company has about $10 billion in debt, according to securities filings. It 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.

In its March 31 statement, China Hongqiao denied the short sellers’ fraud allegations, calling them “untrue and unfounded.” Ernst & Young declined to comment.

China Hongqiao asked 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.”

It isn’t clear whether the government or regulators will step in. 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.

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.

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.

China’s Ministry of Commerce denied the subsidies alleged by the WTO are provided to the industry.

Separately, American aluminum firms have alleged Chinese aluminum magnate Liu Zhongtian has stockpiled aluminum products around the world, sparking a U.S. federal investigation into dumping, or selling products below market prices. Mr. Liu has denied the accusations.

China Hongqiao’s factory in Zouping

China Hongqiao’s factory in Zouping PHOTO: BRENT LEWIN/BLOOMBERG
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Questions about China Hongqiao’s finances were raised 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.”

On Feb. 28, more allegations emerged in a 46-page report by Emerson Analytics, a trading firm that says it focuses on Chinese stock-market fraud.

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.

China Hongqiao in the March 31 statement denied the Emerson report’s allegations and said it hired an investigative agency to look into the firm and people behind the claims. Emerson declined to comment.

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.

Write to Scott Patterson at scott.patterson@wsj.com and Brian Spegele at brian.spegele@wsj.com

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One Response to “Chinese Aluminum Giant Faces Credit Crunch”

  1. daveyone1 Says:

    Reblogged this on World Peace Forum.

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