Monday 13 October 2008

Ferrochina: A wake-up Call for Analysts

The failure of some to sound the warning bell has put their credibility on the line
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Guanyu said...

Ferrochina: A wake-up Call for Analysts

The failure of some to sound the warning bell has put their credibility on the line

By Goh Eng Yeow – The Straits Times
13 October 2008

IT IS becoming too convenient to use the deepening global credit crunch crisis as a diagnosis for all the financial woes confronting listed firms.

True, companies are under stress everywhere, as credit dries up and businessmen find it difficult to raise capital to tide over any temporary cashflow problems.

But giving out loans is the bread and butter business of banks.

Cutting a customer’s credit line is bad for business. The bank gets saddled with the reputation of being a ‘fair-weather’ friend, when things return to normal.

So even in the midst of a severe financial storm, they are unlikely to remove the umbrella from their customers unless they have compelling reasons for doing so.

The bank also runs the risk of getting back a fraction of the loan if the firm goes belly-up.

That is why it is so difficult to believe that banks should have passed the death-sentence on Ferrochina last week by refusing to roll-over its short-term loans of 706 million yuan (S$153 million).

As recently as last month, the company was still giving the impression that it was in the pink of health, updating investors on its expansion plan.

Yet, some traders noted that the warning signs were there, if an investor cared to look.

Over the years, many had expressed concerns at the manner in which company insiders have been whittling down their stakes.

By one estimate, they had sold over 150 million shares, or about 18 per cent of the company, since it was listed in 2005.

Some also recalled the unseemly haste taken by the firm’s pre-IPO investors to get out three years ago during its IPO. None of them kept any Ferrochina shares.

But the biggest warning of all was the alarming 30 per cent plunge in Ferrochina’s share price in the two weeks after reporting that its second quarter profit had tripled to 230 million yuan in August.

This was despite an assurance by the management that there was no negative development. Management even said that it was trying to lure a new investor into its fold.

Not surprisingly, analysts have been bearing the brunt of criticism for continuing to put out ‘buy’ calls on the stock and refusing to heed the warning bells already ringing in the market place.

To be fair to the analysts, nothing mentioned by the management suggested that a crisis was brewing.

Indeed, CIMB-GK analyst Lawrence Lye, who had a buy call on the stock, noted that recent meetings he had with the management ‘yielded no inkling of such problems’.

On the surface, there was also nothing in the second quarter results to suggest that the firm was on the brink of collapse. Revenue for the quarter had jumped strongly by 250 per cent to 3.5 billion yuan, while profits tripled to 230 million yuan. It also had 915 million yuan in fixed deposits and 125 million yuan in cash.

But a closer look produced some disconcerting facts: The firm’s short-term debts of 2.33 billion yuan were more than double the amount of cash on hand.

The banks had also taken literally everything - bank deposits, inventories, buildings - as collateral for their loans.

This means that there is nothing left in the company’s kitty to safeguard against any nasty business downturn. Even those not in business know that this is not a prudent way to run a company.

Next, take the abrupt sell-off of the shares on unusually high volumes in the past two months.

Should it be merely shrugged off as an inability by cash-strapped investors to meet margin calls because of the bearish market atmosphere ?

Or did the plunge suggest something more sinister?

How about management’s assurance about the company’s financial health and expansion plan? Have the analysts tried to verify the claims via independent sources?

Ferrochina’s collapse also raised one ethical issue - companies picking up the tabs for the visits made by some analysts to their operations in China.

Granted, an analyst needs to see at first hand what the firm is doing in order to put together a report to investors. But it also raises a question of objectivity among analysts.

How easy will it be for an analyst to put up a bearish report, after being ‘wined and dined’ by the management?

How easy will it be for him to reverse his positive call if he subsequently develops misgivings about the company’s fortunes?

In many ways, the Ferrochina debacle is a strong wake-up call for the analysts’ community. Their credibility is on the line.

But rather than pointing fingers, let’s move on. It is of paramount importance that analysts get their act together and seek out other potential ‘Ferrochinas’ which may be lurking in the closet.

That way, they can redeem themselves in the eyes of investors by sounding the alarm bell earlier.

Guanyu said...

Dear Tong Jin (DMG)/Lawrence Lye (CIMB)/Kelly Chia (OCBC),

I have a few questions for all of you.

Were you present at the last analysts' plant visit to FerroChina?

If you were present, did the wining and dining by FerroChina's management include KTV sessions? Who paid for the room charges and drinks? Who paid the tips for the lady PROs? Were there any other beyond-the-room entertainment expenses paid by the FRC management?

Regards,
Guanyu