FerroChina trigger cashflow concern – Part 1: FerroChina, China Hongxing

China stock suffered another hit after Ferro China announced that the company is unable to repay working capital loan of 706 million and could default on another 4.52 billion of debt. Obviously, the company is unable to generate cash fast enough to repay debt dued. Give the economic condition and credit crunch, this became a big issue.

Looking at the company last half year result. (Figures in RMB)
Revenue rose to 6,516mil (+206%)
Net profit rose to 418.9mil (+186%)
EPS is 50.52 cents (+43%)

Selling and distribution expenses 25.6mil (+40%)
Administrative expense 64.2mil (+94%)
Finance expense 158.7mil (+174%)
Income tax expense 41mil (+327%)
Net debt/equity 55.7%

The usual numbers show a strong growth. However, the increase of expenses also quite staggering. If you just focus on the profit growth, you might thing the company is doing quite well. Let's look at the liabilities and cashflow.

Current liabilities 6,223mil
Non current liabilities 2,437mil
Amount payable in a year 2,336mil

Operating cashflow before working capital 611mil
Net cash from operating actitivites 198mil
Cash used in investing activities 948mil
Cash from financing activities 709mil
Cash at end of period 125mil
Fixed deposit 915mil

I didn't drill down further to their funding approach and timeline. But if you look at the figures above, you shall be alerted the company might have funding problem. The current cash, FD and operating cashflow is not enough to meet the payable within a year.

Looking at the profit figure is not enough, investor should also study the company cashflow. I am usually not comfortable investing in company with fair amount of debt. The use of debt would enhance the shareholder return, but at the same time increase the risk of default. As a result, I am more favourable to consumer stock which generate strong cashflow.

Questions were raising against other China companies whether they might hit the liquidity problem. Let's take a look at the companies inside my portfolio.

China Hongxing

I have done the Q2 review two months back. This round only focus on the liabilities and cashflow.

Current asset (all figures in RMB)
Bank and cash balance 2,201mil

Current liabilities 227mil
Amount payable in a year 18mil

Operating profit before working capital (6 months) 280mil
Cash used in operating activities (263mil)

The company have negative cashflow due to significant increase in prepayment, deposit and other receivable 592mil. The money was advanced to distributors to set up 219 new stores for six months ended June 2008. Taking into consideration of investing and financian activities, company has 392mil negative cashflow.

As the company complete the store expansion this year, the cash advancement amount should reduce. Together with distributors paying back the amount. Next year, the company should turn cashflow positive. Furthermore, there is cash balance of 2,201mil. No big concern.

Others in part 2 and 3...