Taking the pulse of HK-listed companies: reasons to be rattled

September 24, 2015 16:20
Beijing Capital International Airport general manager Shi Boli (史博利) resigned last week amid reports he was under investigation. Photo: Xinhua

This week, two Hong Kong-listed companies announced the detention of top executives in mainland China, the latest in a string of arrests amid Beijing’s anti-corruption drive.

But it isn’t just disappearing directors that should be sounding alarm bells.

The classic red flags of corporate distress are increasing and suggest tricky times ahead.

Taking an analysis of stock exchange filings, legal records and press reports, the classic warning signs can be broken down into three categories: the not-so-good, the bad and the ugly.

The not-so-good

Profit warnings and going-concern hazards are appearing with greater frequency.

Notable names joining the first category include nightclub operator Magnum Entertainment Group Holdings Ltd. (02080.HK), which said last week it not only expects a loss but is closing its flagship Beijing Club.

Young professionals, it seems, are becoming less flash with their cash.

Likewise, high-end retailers are feeling the squeeze.

Joyce Boutique Holdings Ltd. (00647.HK) also put out a profit warning this month, saying the four months to July this year were in loss-making territory in addition to an anticipated loss in the six months ending Sept. 30, 2015. 

Its peer I.T Apparels Ltd. (00999.HK) is also a notable addition to the profit warning category: last month, it announced that it would take a HK$60 million (US$7.7 million) hit in foreign exchange losses.

Emperor Watch and Jewellery Ltd. (00887.HK) issued a profit warning in July, citing a decline in foot traffic, weak consumer sentiment and increased rents.

A perfect storm for retailers: expect more to follow suit.

Qualified audits are another barometer for lean times, and again the filings are increasing.

The majority are qualified on going-concern fears, meaning the firms face the threat of liquidation.

More than 90 listed companies have made announcements in respect of qualified audits since March this year.

Not surprisingly, given the commodities slump, mining, minerals, oil and gas companies have a significant presence on the list.

Taking a closer look at qualified audits suggest that plugging the financial holes can be a gargantuan task.

Last month, oil and gas storage company Hans Energy Co. Ltd. (00554.HK) said that it was going to have to repay bank loans and interest of HK$129 million within 12 months. The firm had just HK$40 million in cash.

Meanwhile, coal producer Rosan Resources Holdings Ltd. (00578.HK), announced last month that its current liabilities exceeded its current assets by HK$366.5 million.

The bad

This category includes auditors resigning, executives bailing, reams of litigation, windings-up and a prolonged suspension from the bourse due to financial difficulties.

Sixteen companies have put out an announcement in relation to the resignation of auditors over the past 12 months.

This week, it was the turn of Tianhe Chemicals Group Ltd. (01619.HK).

When auditors and a company clash over its financial statements, typically it is seen as a sign that the latter is headed for trouble.

Resignations of executives is another red flag, particularly when they leave en masse or with great frequency.

Replacing the departees with family members, 18-year-olds and trusted managers does not bode well.

When logging and timber firm Superb Summit International Group Ltd. (01228.HK) became the target of a report by US investment research and short-selling specialist Muddy Waters LLC, the board appointed one of the director’s 23-year-old sons.

Superb Summit has been suspended since November 2014.

Prolonged suspensions from the exchange for severe financial difficulties now run to 12, including China Forestry Holdings Co. Ltd. (00930.HK) -- once the darling of The Carlyle Group, the US private equity giant -- and milk formula producer Daqing Dairy Holdings Ltd. (01007.HK), which started out as Global Dairy when it listed in October 2010.

Frenetic or prolonged litigation at a company is also taking a toll: in the past 12 months, 54 companies have announced ongoing lawsuits, a further 17 citing arbitration.

The good news is that to date, winding-up petitions are relatively scarce (12 over the past year), but traditionally these are filed after all avenues for recouping money are exhausted.

A glance at the writs list however reveals the numbers can be big.

The ugly

This category covers arrests, detentions, vanishing acts, investigations and prolonged suspension of a stock because of "irregularities".

On Tuesday, it was the turn of Greens Holdings Ltd. (01318.HK), which announced an investigation by the mainland Public Security Bureau into a subsidiary plus the arrest and detention of two of its directors and a warrant out for another.

Last week, Beijing Capital International Airport Co. Ltd. (00694.HK) announced that general manager Shi Boli (史博利) resigned amid reports he was under investigation.

In July, it was Patrick Liu Chunning of Alibaba Pictures Group Ltd. (01060.HK) who was detained by mainland authorities as part of a graft probe.

Perhaps the most sobering indictment of corporate Hong Kong, however, can be found on the prolonged suspension list for companies with "irregularities" or facing regulatory investigations, currently running at 29, with a marked increase since 2014 and 11 joining the list since February alone.

The most recent addition was Hanergy Thin Film Power Group Ltd. (00566.HK) in May.

Since August last year, however, the reasons given for landing on the list perhaps give the best indication of the detritus that lurks out of sight.

The "issues" identified at the 15 companies named include bogus transactions, sham acquisitions, fake value-added-tax invoice scams, fabricated accounts and undisclosed pledges of massive amounts of money by directors.

If these companies are any indication of what may be hiding below the surface, investors could be in for a turbulent ride.

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EJ Insight contributor