Energy & Resources

Off the rails

Steel woes for railways group

Workers direct a crane to lay a segment of tracks on the Kumul-Lop Nor line's railway bed in Lop Nor

Time to make tracks, lads

The Fortune 500 rankings were first compiled in 1955 and topped by General Motors. Some of the other companies in the top 10 back then don’t sound so familiar, including Esmark at number 5 and Armour at number 7. Both were steelmakers that made huge revenues (hence their inclusion in the rankings) but earned much less profit.

A company that has been surging up the rankings in Fortune’s more recent listings is China Railway Materials Company, or CRM, which specialises in supply chain management in the railway and steel industries. However, the reasons for its astonishing revenue growth now look anything but healthy, reports CBN. Indeed it was recently forced to announce that its profits have evaporated.

According to the Chinese newspaper, CRM boosted its revenues by moving aggressively into shadow banking. But the sagging financials of some of its commercial partners in the steel sector have left it nursing huge losses.

CRM’s 2013 annual report revealed a net loss of Rmb7.65 billion ($1.23 billion) after the group made provisions of Rmb6.1 billion to cover losses on loans to steel traders. This puts the Sasac-controlled SOE into the same league as some of China’s largest lenders such as Citic Bank, which attributed a Rmb7.7 billion increase in non-performing loans last year to its own exposure to steel firms.

CRM’s problems first became evident in its 2012 results. They showed that revenues had rocketed to Rmb231 billion but that profitability had dropped to just Rmb622,000.

CRM’s sales had accelerated since the group first entered the Fortune 500 in 2011 at the number 430 slot. By the following year it had climbed almost 100 places to number 349 after revenues soared more than 45% to Rmb206 billion and profits jumped to Rmb1.13 billion. In 2013 it climbed another 57 places to number 292 in the rankings, just behind ANZ and Mitsubishi Chemical.

As CBN points out, “the company spent decades to achieve revenues of Rmb100 billion and then just three years to reach the second Rmb100 billion.”

It did so by setting aggressive sales targets across its businesses. Employees responded by moving into shadow financing and in particular into entrusted loans and what CBN calls ‘pallet financing’.

According to the central bank, Rmb2.55 trillion of entrusted loans were issued in 2013, equivalent to 29% of all new bank loans in China that year. They usually involve state firms like CRM exploiting their superior credit status to borrow funds from banks at low rates of interest and then entrusting the same bank to release the funds to a second borrower at higher interest rates.

The SOEs are happy because they are making money on the spread. Banks are pleased as they profit from both sides of the trade, while they believe that the credit risk lies with the SOEs, who will get bailed out by the state in event of any difficulties. And the ultimate borrowers are grateful too, especially firms struggling to source finance in their own right.

And so entrusted lending has continued into 2014, despite concerns about the growing risk of a wider collapse in credit. Central bank figures show that a further Rmb716 billion of loans were extended during the first quarter.

Pallet financing is another form of shadow financing. The SOEs again act as middlemen for borrowers with difficulties accessing normal banking channels. In this instance, the state firms raise bank loans to purchase products like steel, which are warehoused. When the trading company sells the steel, it pays back the loan, plus a commission.

However, as WiC has also reported (see issue 229), many steel traders have then been using steel stockpiles as security for a further round of financing (warehousing firms often collaborate by allowing the same quantity of steel to be lent out again and again). That means problems in defaults when there are rival claims on the collateral. But even when ownership rights are clearer, many of the SOEs are stuck with inventory that is difficult to sell at a good price.

Indeed, CBN reports that lending at the railway firm has got so confused that it has ended up in litigation with itself, with CRM Harbin Logistics taking on Wuhan CRM Yitong Logistics. That situation looks likely to worsen if more steel firms go under. Trade body CISA (China Iron and Steel Association) says that about Rmb1.5 trillion of steel loans could be at risk if the lending networks implodes, with state firms on the hook for most of the debt, either on their own account or through backing loans to smaller companies.

CISA said previously that a third of China’s steel traders could fail as a result of slumping prices. The steel industry itself reported a first-quarter loss of Rmb2.33 billion.

And at CRM the debt-to-asset ratio has hit a reported 97.2%, far above the industry standard. The debacle has led to the group’s chairman, president and Party secretary all being removed from their posts, CBN says. And in March, the troubled firm also withdrew its application for a Shanghai IPO because of its weak financials.

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