S&P Cuts China's Credit Rating: Three Operators Fighting Corporate Failure
Standard & Poor's recently downgraded China's sovereign credit rating, lowering it from AA- to A+. The increasing use of debt in the world’s most populous nation to support economic expansion is the main cause for this downgrade, a parallel which is also occurring at the corporate level. CreditRiskMonitor covers more than 4,000 publicly listed companies in China, with more than 15% of those public companies falling into the FRISK® score's high-risk “red zone.”
The FRISK® score is a proprietary model that predicts financial distress, up to and including bankruptcy. The score goes from “10” (best) to “1” (worst), with any score below “6” falling into the aforementioned red zone. Thousands of subscribers worldwide rely upon the FRISK® score to monitor a wide breadth of Chinese corporations.
Corporate financial stress impacts global business tremendously. Financial stress in suppliers is associated with quality-control problems, failure to ship on time, reduced flexibility and less innovation long before the supplier defaults or fails. Counterparties must address these risks promptly, otherwise they face the possibility of wasting valuable time and resources that could have been put to better use elsewhere. CreditRiskMonitor encourages subscribers, including credit and procurement professionals, to pay attention when their counterparties’ FRISK® scores move into the red zone category. A drop into the red zone is a wake-up call for counterparties to address the degree of financial risk and mitigate exposure, if required.
Many Chinese companies have been rightly criticized for lapses in their accounting and poor governance. Yet, excessive leverage is the most visible issue in 2017. To highlight the debt issue on a company specific basis, we searched our database for Chinese entities with a FRISK® score of “3” or less and who also exhibit a high degree of leverage. Yingli Green Energy Holding Co. Ltd. (Yingli), MIE Holdings Corp. (MIE), and Ji Lin Ji En Nickel Industry Co. Ltd. (Ji Lin), which all operate in highly commoditized industries, caught our attention.
Yingli is a solar panel manufacturer that largely serves U.S. and Chinese commercial customers. Yingli has a FRISK® score of “1,” which is the worst possible rating on the FRISK® scale. If action has not already been taken, we recommend that customers and suppliers take steps to reduce financial exposure.
In Yingli’s second quarter 2017 earnings report, it showed a 26% year-over-year rise in sales revenue, which was a direct result of increasing deliveries. That’s pretty much where the good news ends, however. Management stated that the company will realize further gross margin pressure, as it will need to match competitors' pricing as panel manufacturing is still experiencing a declining cost curve. Unfortunately, operating losses continue and Yingli remains highly dependent on debt financing. See the trend in debt to assets on year-over-year basis below, which rose to a painful 87% in the most recent quarter:
MIE is a distressed oil & gas exploration and production company. It primarily operates in Northern China, though it also has operations in Kazakhstan and the U.S. Lower crude oil and natural gas prices have been a notable issue here, as is falling production volume. In the first half of 2017, the company experienced lower volumes after selling a piece of its equity interest in its Kazakhstan subsidiary, as well as organic declines in its Chinese fields. Management expects better results in the second half of 2017, yet its overall performance trends are highly unhealthy. Regarding the company’s leverage, note the significant increase in the debt-to-assets ratio over the last five quarters:
Fitch Ratings also showed that leverage will expand beyond the figure shown for the period ended 6/30/2017, following the acquisition of recently targeted Canadian assets. Moreover, the credit agency doesn't expect the new assets to add materially to cash flow, explaining that: “...MIE is unlikely to receive any meaningful cash distribution from the target company after the target company meets its capital needs and debt servicing requirements at the newly formed subsidiary level.” Given that its FRISK® score currently stands at the lowest level of “1,” customers and suppliers alike must proceed with caution when dealing with this operator.
Lastly, we identified Ji Lin, an operator involved in metal processing and chemical production. Over the last 12 months, its FRISK® score has stood at a “3,” which signals elevated financial risk compared to an average public company. In 2017, the company released a statement about a turnaround plan – a process expected to require several years to complete.
One issue Ji Lin is facing at present time is that the metals they derive earnings power from have experienced significant pricing headwinds, e.g. nickel, with prices actually hovering near the lowest levels seen in nearly a decade. Meanwhile, the company has overdue debts which have contributed to ballooning interest expenses. Like the two companies above, Ji Lin has an elevated debt-to-asset ratio, standing at 64% at the end of its most recent quarter:
Ji Lin has been de-listed from the Shanghai stock exchange due to two consecutive years of net losses, and will remain so until it works through its hurdles.
These three multi-billion dollar companies each have a highly leveraged capital structure and, if not addressed, could find themselves on the path of corporate failure. Unfortunately, these operators are just a small sample of the many troubled Chinese companies CreditRiskMonitor covers today. Both credit and corporate supply chain sides of the business should be implementing appropriate risk mitigation procedures to help protect against such risks before it is too late. The aforementioned S&P downgrade is just one of many recent warnings from respected observers that corporate finance in China is a global trouble spot.
CreditRiskMonitor is a financial news and analysis service designed to help professionals stay ahead of public company risk quickly, accurately and cost-effectively. More than 35% of the Fortune 1000, plus thousands more worldwide, rely on our commercial credit reporting and predictive risk analytics for assessing the financial stability of more than 56,000 global public companies.
At the core of CreditRiskMonitor’s service is its 96%-accurate FRISK® score, which is formulated to predict public company bankruptcy risk. One of four key components calculated in the FRISK® score is crowdsourced subscriber activity. This unique system tracks subscribers' patterns of research activity, capturing and aggregating the real-time concerns of what are essentially the key gatekeepers of corporate credit. Other features of CreditRiskMonitor’s service include timely news alerts, the Altman Z”-Score, agency ratings, financial ratios and trends. CreditRiskMonitor’s network of trade contributors provides more than $150 billion in trade data on their counterparties every month, giving them visibility into their biggest dollar risks.