The fall of China’s most profitable coal miner is a cautionary tale

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Less than ten years ago, Yongcheng Coal and Electricity Holding was one of China’s most famous energy companies.

With vast reserves of high-quality coal at its mines in central China’s Henan Province, the country’s government-controlled banks were eager to extend cheap credit to the company. At its peak in 2013, the company’s annual turnover was 127.4 billion Rmb ($ 19.5 billion).

“We were the most profitable coal mine with the highest wages in the country,” said a senior Yongcheng executive, who asked not to be identified, from that period.

A dramatic decline has changed all that. Yongcheng Town, where the group is based, is now pockmarked with half-built and dilapidated buildings. The company’s struggling workers, many of whom haven’t been paid for months, have taken to packing and selling flour to make ends meet.

But Yongcheng’s woes only gained national significance last month, when the company by default on bonds worth 3 billion rmb.

This development has disrupted China’s $ 15 billion government debt market, the second largest in the world, and triggered a series of defaults in other local government-controlled companies, which account for a large portion of the country’s economy.

Defects ricocheted through China’s financial system. Analysts say state-linked companies are now having difficulty raising capital. The episode also erased long-held investor assumptions that authorities will always bail out state-owned enterprises in China.

“The biggest impact has been on other state-owned issuers,” Chen Long told Plenum, a Beijing-based consultancy. “Henan state-owned enterprises have not been able to issue bonds in recent weeks. The more companies can no longer issue bonds, the worse the problem will be. “

Some believe Yongcheng’s struggles could be a harbinger of trouble in other state-linked groups across China. “Yongcheng’s business failure could happen to any state-owned company with weak fundamentals,” added a Beijing-based investor who bought the company’s bonds. “A lot more flaws could be in the pipeline.”

In Yongcheng’s case, the group’s downfall was seeded by the financial collapse of its parent company, Henan Energy and Chemical Group. HECG has forced the coal miner to issue increasingly expensive bonds and borrow from China’s less regulated shadow banking sector at a time when the general credit environment is tightening.

This transformed Yongcheng from what his bankers considered a low-risk borrower to a much riskier proposition with a myriad of creditors.

The woes of Yongcheng and its parent company date back more than a decade, when the latter launched an unfortunate expansion in chemicals derived from coal.

The company earned HECG a spot on the 2011 Fortune 500 Global Top Companies List, prompting the Henan provincial government to call a press conference to celebrate the milestone.

HECG aimed to become “a world-class coal company,” said Chen Xiang’en, then chairman of the group, of its pivot to high-end chemicals, which would eventually lead to heavy costs. losses for the company.

Prices for ethylene glycol, one of HECG’s biggest chemicals, have fallen by almost two-thirds since the group started manufacturing it in 2011 due to a glut of supply, with little respite on the horizon. “The chemical coal industry in China is facing an oversupply that could take many years to be absorbed,” said Qi Dan, analyst at Baiinfo, a consultancy firm.

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As its difficulties in the chemicals market intensified, HECG struggled to service its bank loans. As a result, he turned to China’s nascent bond market, where he has raised Rmb 60 billion ($ 9.1 billion) in the past five years, according to public records.

“We have paid a price to expand our footprint without considering profitability,” said a senior executive at HECG.

In order to consolidate its finances, HECG has started to put pressure on Yongcheng, its best-performing subsidiary, to exploit the bond markets. Yongcheng has raised RMB 66 billion in debt since 2018, typically paying investors around 6% interest.

But Yongcheng also turned to more expensive fiat loans – off-balance sheet loans from banks and other financial institutions – with interest rates between 6.5 and 7.5 percent. According to people directly familiar with Yongcheng’s fundraising activities, a significant portion of the proceeds from its bond and trust loans were used to repay debts at HECG.

Yongcheng has not been open with his investors about this, often telling them that he is raising cash to replenish working capital or pay off his own debt. China’s National Association of Institutional Financial Market Investors, a regulator, last month accused four of Yongcheng’s bond underwriters, its auditor, a rating agency, and HECG of breaking capital market rules. . Yongcheng and HECG declined to comment.

Bar chart showing China's domestic debt market by issuer

Some Yongcheng creditors say they knew the miner was supporting HECG, but assumed the Henan provincial government would support the two companies because of their strategic importance to the local economy, which thrives on exports of coal and flour. . But they did not anticipate the Covid-19 pandemic, which criticized the finances of many regional governments.

“We knew HECG was dragging Yongcheng down,” one investor said. “But HECG is Henan’s largest state-owned enterprise, and the provincial government cannot afford to let it go.”

Hopes of a full Henan bailout are fading as the provincial government grapples with its own growing budget deficit.

Two Yongcheng bondholders told the Financial Times that HECG assured them in early November that the local government would inject RMB 15 billion into the group to solve its debt problem. But less than half of that has arrived, according to people with direct knowledge of the situation. “We maintained our confidence in government support until the last moment” before the default, said one of the investors.

Since Yongcheng’s default, more than 260 state-owned companies have suspended bond issuance. Those who have gone ahead must pay higher interest rates.

“Now that government guarantees are gone, underperforming state-owned companies have to pay higher interest or they won’t have access to credit markets,” said the head of credit ratings at a Beijing-based bond investor.

For many employees who are going through hardships due to the hardships of the business, Yongcheng’s fall was a humbling experience.

“Ten years ago, I could earn 12,000 Rmb per month when my friends from other companies made less than 2,000 Rmb,” said an engineer from Yongcheng who has worked in the company for 15 years, but who doesn’t has not been paid for six months.

He now sells flour for a living. “Now I have to live without pay for six months and there is no update on when my next paycheck arrives.”

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