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

The phrase "patriotism is the last refuge of a scoundrel" is often misapplied, but it is a perfect description of the world's largest alumnimum producer's response to fraud charges. Hongqiao Aluminum created the "Hongqiao model" whereby aluminum producers generate their own electricity. Given lax regulation in China and officials willingness to look the other way when GDP growth and financial stability are in question, it doesn't require a stretch of the imagination to think producers might be cheaply operating coal-fired power plants. It has enough plausibility to fool investors who might not dig too deeply into the numbers. However, some analysts did dig into the numbers. Instead of developing a low cost method of energy production, short-sellers argue the firm used its electricity generation to cook its books, vastly understating its electricity costs.

With shares halted on the Hong Kong exchange, Hongqiao isn't addressing the specific charges. Instead, it is lashing out at a "U.S.-led Western attack" on China's aluminum industry. It's not the worst strategy in a world with rising nationalist sentiment and at least a rhetorical barrage of protectionist sentiment from President Trump. Still, the evidence suggests this is a last ditch effort. Well, second to last. If the appeal to patriotism fails, Hongqiao has one more argument: the industrial cluster built around its companies in Binzhou, Shandong Province are responsible for more than 50 percent of 500 billion yuan in GDP, and more than half of the 200 billion yuan in local debt.

iFeng: 山东魏桥求援:沽空如处理不当将危及2000多亿贷款
China's largest electrolytic aluminum enterprises, Shandong Binzhou Zouping County private enterprises Weiqiao Group on March 1 encounter foreign institutions short, the group's listed company China Hongqiao (01378.HK) accused of financial fraud, said it significantly higher than the industry The profits are actually false. Over the past month, China's Hongqiao has not yet made a strong refutation of the short selling report itself. China Hongqiao and Weiqiao Group, another listed company Weiqiao Textile (02698.HK) have issued a delay in the release of performance reports, and both shares have been suspended.
For background see this story at Aluminum Insider: Metal Fatigue – Has China Hongqiao’s Weiqiao Model Run Its Course?
In addition to discrepancies involving power generation, Emerson revealed interesting numbers surrounding Hongqiao’s purchase of alumina. Comparing alumina production costs reported by Hongqiao against those of similar companies operating in the same province, Emerson reported the cost per ton differed by generally RMB300 between prices claimed by Hongqiao and those reported by the other companies in the area. This difference of roughly 20% between the reported price and the apparently actual price means that, according to Emerson, Hongqiao could be hiding up to RMB2 billion in production costs. In addition to apparently under-reporting alumina production costs, Emerson also points out discrepancies with the purchase of alumina from companies that are allegedly third parties. Gaoxin A&P, from whom Hongqiao buys the vast majority of outside alumina, sold Hongqiao the aluminium precursor for an average loss of CNY273 per ton from 2011 to 2015, racking up an estimated CNY6.62 billion. Though allegations by others have been made claiming that Gaoxin is an undisclosed related party, Emerson simply asks Hongqiao why an unrelated company would sell at a loss for so long that debts from the practice would significantly outweigh the firm’s assets.
The full Emerson Analytics report is here (PDF): China Hongqiao – Electrifying Margins to Absurd Levels
China Hongqiao raised Rmb5.2bn in its 2011 IPO to set itself off on the path to becoming the world's largest aluminum producer. Our investigations show it began cooking its books at the IPO stage by underreporting
production costs and purchasing electricity and alumina from connected parties at exceedingly low prices.

China Hongqiao's net margins were similar to those of its peers from 2007 to 2009. In 2010, it claimed a sharp improvement to a staggering 27.7% when its peers continued to struggle with single-digit margins. In subsequent years, China Hongqiao persisted with its accounting irregularities and reported margins far higher than those of its peers.

The company's success is not built on the use of self-supplied electricity as its peers also have captive power plants. We have used three independent methods (working through China Hongqiao's numbers in great details, talking to its ex-staff, and relying on data from an industry consultancy) to show that the true cost of its electricity generation is 40% higher than its claim. In 1-3Q2010, when coal price went up 23%, China Hongqiao dared fabricate a 33% drop in the unit cost of its self-supplied electricity.
Back to iFeng:
Two recent documents show that in the critical juncture, Weiqiao Group has to China Nonferrous Metals Industry Association for help, will be attributed to their own short selling hit Alcoa and Rio Tinto's commercial interests. The two documents are the "Report on Emergency Response to US Agency Short Events" submitted by the Weiqiao Group to the Nonferrous Metals Association, and the Non-Ferrous Metals Association submitted to the Ministry of Industry, "to prevent and respond to the US-led Western countries to contain China's aluminum industry Letter of advice".
There is a grain of truth to their complaint.

FT: Call to tackle China’s soaring aluminium output
An international coalition of aluminium trade associations has called for a global forum to be created ahead of the G20 meeting in Hamburg this summer to tackle China’s soaring output.

Russian companies, hit particularly hard by Chinese production, are also backing the initiative by trade groups from the US, Europe and Canada, which represent companies including Rio Tinto and Alcoa.

“This situation not only significantly distorts international trade flows affecting all of our countries but also undermines global stability,” the three trade associations said in a letter to G20 leaders.
Hongqiao takes it much further though. The phrase "patriotism is the last refuge of the scoundrel" is appropriate here. Honqiao doesn't address any of Emerson's direct charges about electricity costs, instead shifting attention to raw materials. Hongqiao thinks a new source of bauxite led Alcoa and Rio to strike back.
For the reasons for the short selling, Weiqiao Group speculated that the direct incentive began in 2015. At that time, by the Weiqiao Group-led Guinea's bauxite mine project completed and put into production. Weiqiao Group analysis, the project put into operation led to Alcoa, Rio Tinto and other giants lost the global market price of raw materials pricing, directly hit its fundamental business interests.

Weiqiao Group believes that before and after the release of short reports and a series of actions, the biggest consequence is to force the Weiqiao Group auditors in the 2016 annual audit, to take "extreme conservative and cautious attitude." If the two listed companies can not complete the annual audit work, will eventually be caught by the Hong Kong Securities and Futures Commission, the Stock Exchange for investigation, long suspension and can not carry out the normal production and operation of financing risk.

...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.

...The past two years, the situation is even worse. Association pointed out that from the past two years, the United States on China's aluminum industry to carry out containment action, showing from the economic level to the political level, from bilateral contradictions to multilateral contradictions, from trade sanctions extended to the entity, from the attack industry At the same time on the individual enterprises to break the situation.
If appeals to patriotism don't work, Hongqiao also warns of social unrest:
"The two major industrial clusters involved 300,000 people in direct employment, once the risk spread, is bound to lead to severe social unrest"

...Weiqiao Group in the report details, Weiqiao Group is one of the world's top 500 enterprises, the top three Chinese private enterprises, 2016 group sales revenue reached 375 billion yuan. Weiqiao Group's textile, aluminum two business segments, are the world's largest and most profitable. In addition, Weiqiao Group is the core of Binzhou City, formed a textile, aluminum two major industrial clusters, more than 2,000 enterprises, the integrated annual output value of more than 500 billion yuan, total employment of nearly 300,000 people (of which Weiqiao Group employees 16 people, more than 10,000 employees upstream and downstream), Binzhou City, a direct contribution to more than half of the GDP, accounting for more than half of the local financial institutions, the total size of credit, up to 200 billion yuan.
When the tide goes out, you can see who is swimming naked. In this case, the tide is liquidity. Only a year ago, Hongqiao was ramping up capacity amid a burst of monetary emissions.

FT: China Hongqiao undeterred by aluminium glut
China Hongqiao, the world’s largest aluminium producer by capacity, on Monday said it planned to increase capacity to 6m tonnes by the end of 2016 from 5.19m tonnes at the end of last year, depending on market conditions.

Zhang Bo, chief executive, said: “If demand is good, we will stick with the plan. If not, we can slow down new capacity expansion or even suspend it.”

The group added it would spend up to Rmb15bn ($2.3bn) in expanding capacity and retrofitting coal-fired power plants to meet China’s stricter emissions requirements.
Even without the fraud charges, Hongqiao is a microcosm of a Chinese industrial economy riddled with debt-financed excess capacity (and for the more skeptical, the book cooking is part of the microcosm too). This is merely one part of a wider debt-blowup in Shandong province covered yesterday (Shandong Bad Debt Daisy Chains Exploding, Loanshark City Falls on Hard Times). More stories will follow as long as credit growth is restrained and China cracks down on real estate. Beijing's harsh attack on the real estate sector is being held up as a model for the country, thus a new wave of national tightening is expected. (Beijing Bans House Flipping, Punishes 55 Agencies) Tianjin is the latest city to tighten.

Last year, new credit growth was driven by real estate activity. In July, 102 percent of new bank loans were mortgages. Conservatively, one-third of new lending in 2016 went into real estate. There are reports saying in the second half of 2016, mortgages accounted for as much as 80 percent of new credit in some cities.

Mises said: There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. China's response to every nascent crisis has been further credit expansion. Evidence suggests another "bust" is underway. With real estate still tightening, credit should slow more than expected if other sectors do not offset it with increased borrowing. If another round of credit expansion is the solution, raise your long-term USDCNY target.

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