Debt crisis erupts at Tianjin's largest SOE

This is an edited and translated version of a Chinese article published earlier on fundsupermart.com.hk on 3 May 19.

The largest state-owned enterprise in Tianjin, Tewoo Group Co., Ltd, has been facing a liquidity crunch recently. The group is ranked first among Tianjin Top Hundred Enterprises and is the first company in Tianjin to be listed among the Fortune Global 500. Tewoo applied for a bank loan extension on 3 April 19. Subsequently on 8 April, the group announced the sale of its copper stocks to ease its tight financial liquidity condition. On 9 April, Fitch Ratings placed Tewoo Group on negative watch, and downgraded the company’s rating from ‘BBB’ to ‘BBB-’ on 18 April. Finally on 29 April, Fitch again downgraded Tewoo’s credit rating, this time by six notches to ‘B-’.

The market reacted strongly since Tewoo Group went into debt crisis, and investors sold in droves its notes fearing a default event. The prices of Tewoo’s two bonds available on our investment platforms (see Figure 1) both recorded sharp declines, plunging more than 20% over a one-month period (see Figure 2 and 3). The market has differing opinions concerning the ability of Tewoo Group to pay off its debt, which is the topic of this article.

Figure 1:

Figure 2: TEWOOG 4.625% 06APR2020 CORP (USD)

Figure 3: TEWOOG 5.500% 06APR2022 CORP (USD)

Company background

Tewoo Group is Tianjin’s largest state-owned enterprise and wholly owned by the Tianjin State-owned Assets Supervision and Administration Commission (Tianjin SASAC). According to its group website, the group has 217 subsidiaries and 17,000 employees worldwide. Tewoo operates in production materials logistics and distribution, with its five main business segments comprising metals, energy, minerals, chemicals, and automobiles and electromechanical products. Tewoo Group’s consolidated total assets at book value are huge, ranking it among Fortune Global 500 for seven consecutive years since 2012—it was ranked 132nd on the list in 2018.

Bond default a foregone conclusion?

As of the third quarter of 2018, Tewoo Group’s total assets (unaudited) stood at RMB245.7 billion and its total liabilities stood at RMB188.0 billion, while the group’s net profit in 3Q18 was only RMB380m, down 12% year-on-year. Tewoo Group reportedly raised nearly RMB18.5 billion worth of debt in China and overseas as of 19 Apr 19. Domestic debt accounted for RMB4.63 billion as of September 2018, with RMB600m worth of bonds maturing by September this year. In terms of overseas debt, Tewoo Group had borrowed more than USD2.05 billion through its overseas subsidiaries, out of which USD300m of bonds will mature in December this year. Our back-of-the-envelope calculations show that Tewoo Group has around RMB2.622 billion of borrowings due in 2019. In addition, Tewoo Group will also need to repay its bank mortgages and accounts payable. These two types of liabilities typically rank senior above unsecured bonds. Considering that Tewoo Group has been unable to pay its bank loans on time, we think the group is left with little cash and cash equivalents. Even if Tewoo divests its assets for debt repayment, it would only serve to temporarily ease its liquidity crunch. At the same time, as Tewoo continues to be mired in maturity extension talks with its bank lenders, we think the likelihood of the group being able to refinance its debt by borrowing from banks or the bond market is low, and its default risk is high.

There were early signs of Tewoo Group’s debt crisis. The bankruptcy of Bohai Steel Group Company Limited in 2018 triggered systemic risk in Tianjin’s financial market. The incident involved a large number of local companies and financial institutions, which recorded huge amounts of bad debt. Financial institutions became more conservative in their lending standards, and this resulted in liquidity issues for a number of Tianjin enterprises. At the same time, Beijing’s deleveraging and capacity reduction reforms made it difficult for a traditionally highly-leveraged company like Tewoo to raise financing. The default in May 2018 by Hsin Chong Group Holdings Limited, a company controlled by Tewoo, showed further signs of financial problems at Tewoo Group.

Chances of a bankruptcy reorganization is higher

Tewoo’s debt issues that had surfaced from its current crisis may be only the tip of the iceberg. Tianjin’s economic growth has slowed down sharply since the beginning of 2016. GDP growth dropped to 1.9% in the first quarter of 2018. Even as it started to rebound thereafter, the outlook is still pessimistic, with GDP growth in 2018 less than 4% (see Figure 4), which ranked last in the country. On the other hand, according to a 2016 report released by ratings agency Moody’s, state-owned enterprises in Tianjin recorded an aggregate liability-to-fiscal revenue ratio of more than 600%, which was the highest in the country. At the same time, as shown in Tianjin municipal government’s most recent three-year revenue and debt data (see Figure 5), Tianjin government’s fiscal revenue has declined significantly since 2017. Fiscal revenue fell by close to RMB40 billion in 2017, while government borrowings rose rapidly. By the end of 2018, debt owed by the Tianjin government was almost double its fiscal revenue. We expect local government debt to continue to grow, and the debt crisis may deepen in the future. The bankruptcy of Bohai Steel, a Tianjin SOE, in 2018 may also be a sign that the Tianjin government has lost control over the local debt crisis. Other than Bohai Steel and Tewoo, there have been a number of state-owned companies in Tianjin that are fighting to stave off insolvencies, such as Tianjin Real Estate Group Co. Limited, which owes RMB200 billion in debt. From the above observations, we think that in the event of a default by Tewoo, the company is likely to go into bankruptcy reorganization in a similar way as Bohai Steel, which has brought in capital from the private sector for its corporate restructuring. But for bondholders, recovery of their investments may be difficult, and potential loss heavy.

Figure 4:

Figure 5:

Conclusion

In our view, Tewoo Group carries extremely high default risk, and bondholders who wish to avoid this risk may consider to divest their TEWOOG bonds as soon as possible. On the other hand, the number of potential buyers of the TEWOOG bonds has reduced since the emergence of the company’s debt crisis, and trading liquidity has weakened. This incident has also served to remind us that even investment-grade bonds have the risk of defaulting. As such, instead of relying on any single factor, we should seek to have an overall understanding of the bond issuer’s operating conditions and external environment in our process of evaluating bonds.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst(s) who produced this report hold a NIL position in the abovementioned securities.