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Shanghai Electric's $1.4bn in uncollected bills spook market

Power equipment maker goes to court against tardy state enterprises

A Shanghai Electric subsidiary selling network communication products is owed nearly $1.4 billion from buyers, mostly fellow Chinese state-owned enterprises.   © AP

HONG KONG -- A top Chinese producer of energy equipment, with a corporate history tracing to the Qing dynasty in 1902, has sparked investor and analyst worries after the manufacturer warned that other state-controlled businesses had fallen behind on almost $1.4 billion in payments.

Shanghai Electric Group's shares have dropped by 16% in Hong Kong and 15% in Shanghai since the potential losses were disclosed before trading on May 31. Moody's Investors Service and S&P Global Ratings have cut their outlook on the company's credit rating to "negative" as they review the situation.

The group, in a filing, said it "gradually discovered" in late April that clients of subsidiary Shanghai Electric Communication Technology were "generally overdue" on 8.67 billion yuan ($1.35 billion) of invoices. This amount represented 86% of the total assets of the subsidiary, which sells network communication products, as of Dec. 31 and nearly three times its annual revenue.

Shanghai Electric signaled that its subsidiary's troubles could prompt write-downs reaching 8.3 billion yuan, surpassing the 7.26 billion yuan in net profit the group generated between 2019 and 2020.

The difficulties hitting a core state-owned enterprise controlled by the city of Shanghai shed light on credit risk in China, where the country's uneven recovery from the coronavirus pandemic, tightened credit conditions and other factors are seeing companies fall behind on more bills and debts.

Shanghai Electric, which also has a large business making manufacturing equipment, generated 21.64 billion yuan in overseas sales last year, or 16% of total revenue.

It has long been mired in a legal dispute with Indian billionaire Anil Ambani's company Reliance Infra Projects (U.K.) over unpaid bills for equipment and related services supplied for a coal-fired plant in the central Indian city of Sasan. An application for arbitration was accepted in Singapore in February involving a total contract value of $1.31 billion.

Shanghai Electric Communication is fully consolidated on its parent's books since the group is its top shareholder, with a 40% stake, and controls its board of directors.

The subsidiary likely faces a substantial net loss this year, given the uncertainty over collecting the overdue receivables. That would trigger an impairment loss on Shanghai Electric's equity investment in the unit of 526 million yuan. A much bigger loss could be incurred on a loan of 7.765 billion yuan to the unit from Shanghai Electric, which is due to mature between November and next May.

Creditors could also potentially chase the group over a bank loan of 1.25 billion yuan taken out by the subsidiary. Shanghai Electric did not provided a guarantee on the debt, but did issue comfort letters and liquidity support letters related to 902 million yuan of the outstanding loan, which matures between June 29 and Feb. 15.

The unit has sued four companies in two local Shanghai courts, looking to recover an aggregate of 4.46 billion yuan, about half of the total overdue receivables.

Shanghai Electric has been negotiating to buy control of Pakistani utility K-Electric.    © Reuters

All four defendants are state-owned enterprises. The largest debtor is Nanjing Changjiang Electronics Group. Shanghai Electric is seeking more than 2 billion yuan from this unit of China Electronics Corp., an elite, central government-controlled conglomerate listed last week by the Biden administration as a company linked to the Chinese military and subject to sanction.

Moody's and S&P Global are reviewing the company's credit ratings for a possible downgrade from their scores of A3 and A-, respectively. Both give it a three-notch advantage due to due to its strategic importance to China's economy and its crucial role in economic diplomacy, such as exporting energy equipment and facilities to Pakistan and other Belt and Road Initiative countries.

Both credit agencies expect China's government to come to the group's aid if necessary. But they warn of likely deterioration in the credit profiles of Shanghai Electric and unlisted parent Shanghai Electric (Group) Corp.

A potential loss of the magnitude implicated by last week's disclosure would worsen the group's high leverage. Chloe Wang at S&P wrote June 1 that Shanghai Electric's leverage, in terms of debt to earnings before interest, tax, depreciation and amortization, hit 4.6 in 2020, "well above our downgrade trigger of 4."

The agency cut its credit score on Shanghai Electric just before the disclosure of the subsidiary's troubles, citing heavy investments and a weak profit margin. But another downgrade is on the horizon if profit is to "worsen considerably in 2021-2022."

Shanghai Electric's case also highlights governance issues. Gerwin Ho, a senior credit officer at Moody's, wrote in a note June 1 that "Moody's regards the uncollectable receivables issue as an indication of potential weakness in the internal controls and governance practice" of both Shanghai Electric and its parent.

Wang echoed this point, saying the incident reflects "deficiencies" in the group's risk management and internal controls as well as a lack of oversight. The subsidiary's typical practice of taking 90% of payments in installments after its goods are delivered "already presents heightened receivables risks compared with most of the group's other businesses," she said.

The subsidiary's "heavy exposure to customers that are government-owned entities likely resulted in the group's looser control on working capital and failure to identify red flags early on," she said.

Fitch Ratings last Friday cited no immediate impact on its rating of the group from the disclosure about its subsidiary, viewing the case as "an isolated event." But Laura Long, a director in Beijing, wrote, "Negative rating pressure could emerge if there are more cases of delinquent receivables, which would prompt Fitch to re-evaluate [the group's] risk and internal control measures."

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