Zoomlion Biggest Short as Bears Bet China’s Building Binge Will Slow Down
Short sellers have never been so sure that Zoomlion Heavy Industry Science & Technology Co., China’s second-biggest maker of construction equipment, will drop as building slows and customers fall behind on payments.
Speculators lifted bets against Zoomlion to 22 percent of shares outstanding last month, the highest proportion on record and the most among Hong Kong-traded stocks tracked by Data Explorers. Bearish wagers increased even after the stock tumbled as much as 47 percent this year to an all-time low on Sept. 26.
Zoomlion, whose sales of cranes and concrete machinery in China make it a gauge of the world’s largest building boom, posted a 50 percent gain in first-half revenue and a 110 percent jump in profit, four times more than the Hang Seng China Enterprises Index (HSCEI) average. The company spurred sales by letting customers buy machinery without paying upfront, a strategy that some investors say may backfire after banks curbed real-estate loans. Zoomlion shares gained 8.9 percent through yesterday from this year’s low as China eased lending restrictions to bolster the economy.
“It’s going to be difficult to maintain the same pace of growth,” said Alex Au, a Hong Kong-based managing director at Richland Capital Management Ltd., which oversees about $300 million and is selling short Zoomlion shares. In a short sale, traders sell borrowed stock, anticipating the price will drop so they can profit by buying back the shares at a lower price.
Chen Yingzi, a spokeswoman for Zoomlion, based in Changsha, Hunan province in south-central China, didn’t respond to three phone calls and an e-mailed request for comment. Zoomlion shares snapped three days of losses, climbing 5.2 percent to HK$8.26 as of the close in Hong Kong.
Zoomlion’s chairman and chief executive officer, Zhan Chunxin, said in a Nov. 15 interview in Hong Kong that slower expansion in Chinese demand for building equipment will continue next year because of waning economic growth and cutbacks in railway building. Meeting a 50 billion yuan ($7.9 billion) sales target this year will be “challenging,” he said.
Policy makers in Beijing are taking steps to support growth in the second-largest economy, which may improve investor sentiment toward the construction industry, according to Manulife Asset Management. The People’s Bank of China cut the amount of cash banks must keep in reserve for the first time since 2008 on Nov. 30, to 21 percent from a record 21.5 percent.
Zoomlion shares have dropped 42 percent this year, bringing its market capitalization to HK$70.9 billion ($9.1 billion), data compiled by Bloomberg show.
The company’s 6.5 percent yuan-denominated bonds due in April 2016 yield 6.09 percent, up from 5.7 percent at the end of 2010, according to data compiled by Bloomberg. The yield on JPMorgan Chase & Co.’s index of corporate debt in emerging markets has climbed to 6.25 percent from 5.8 percent.
Zoomlion is rated AA- by Beijing-based Dagong Global Credit Rating Co., the fourth-highest investment grade, according to data compiled by Bloomberg. It isn’t rated by Standard & Poor’s, Moody’s Investors Service or Fitch Ratings, data compiled by Bloomberg show.
Zoomlion’s valuation in the stock market is low relative to its history and peers, according to data compiled by Bloomberg. The company’s Hong Kong-listed shares trade for 5.6 times profits, compared with a historical average of 11 times, the data show.
Sany Heavy, Caterpillar
Sany Heavy Industry Co. (600031), China’s biggest maker of construction equipment, trades at 10 times earnings in Shanghai and has a market value of $14 billion. Peoria, Illinois-based Caterpillar Inc. (CAT), the world’s largest construction and mining- equipment maker, is valued at 13 times profit in New York and has a market capitalization of $60 billion.
Short sales of Zoomlion slipped to 20 percent of shares outstanding on Dec. 8 from a high of 22 percent on Nov. 22, according to New York-based Data Explorers, which makes estimates by analyzing securities lending data from custodian banks and fund managers. Bets against Caterpillar are about 1.4 percent of shares outstanding, the data show. Short selling of Sany Heavy’s shares isn’t allowed in Shanghai. The company said it delayed plans for a Hong Kong stock sale in September.
“If China keeps loosening policy, then the market will look ahead and some of these stocks are trading at quite low valuations,” Terrace Chum, the Hong Kong-based managing director of greater China equities for Manulife Asset Management, which oversees about $199 billion, said in a Dec. 1 interview, declining to speak about individual stock holdings.
Zoomlion has 18 stock recommendations equivalent to “buy,” seven holds and three sells, according to analyst recommendations compiled by Bloomberg. The average 12-month price estimate for the stock is HK$12.42, or 58 percent higher than the closing price of HK$7.85 yesterday, the data show.
“Investors have overreacted on the risk for its financial leasing business,” said Stanley Yan, an analyst at Taipei-based Masterlink Securities Corp. (2856) who had a “buy” rating on Zoomlion as of September, according to data compiled by Bloomberg.
Investors are increasing bearish bets against Zoomlion a year after the company sold shares in Hong Kong for the first time. Zoomlion raised HK$13 billion last December, following an increase in fixed-asset investment in China that lifted spending on construction equipment by 92 percent to $35 billion in 2010, according to data compiled by Bloomberg and consulting firm Off- Highway Research in London. That’s more than the combined equipment sales in the U.S., Europe, Japan and India, the data show.
Industry sales growth in China will probably slow this year to 5 percent, according to Off-Highway Research, after a government crackdown on real-estate speculation led developers and cities to scale back projects. As state-owned banks reduced lending, Zoomlion has provided more financing and loan guarantees to its customers, according to the company’s semi- annual report.
“Equipment leasing is becoming a bigger factor in promoting sales” for construction-equipment manufacturers, said Nicholas Yeo, the Hong Kong-based head of China and Hong Kong equities at Aberdeen Asset Management Plc (ADN), which oversees about $260 billion. Yeo said he doesn’t own Zoomlion shares. “We don’t know how prudent or conservative these companies are in their leasing and we won’t be able to tell unless we have a credit crunch.”
Buyers of construction equipment are struggling to meet their obligations, according to Julian Bu, who oversees research on Chinese industrial stocks at Jefferies Group Inc. in Hong Kong. Forty-one percent of firms that purchased excavators made by local companies in the two years through October are late on payments and 7 percent have defaulted, according to a Nov. 24 report by Jefferies which cited data compiled by the Construction Machinery Dealers’ Association in China.
“The outlook for the sector is not good,” said Au, whose Richland Asia Absolute Return Fund rose 3.6 percent this year through Nov. 30, compared with the MSCI Asia Pacific Index’s 18 percent drop, according to data compiled by Bloomberg.
About 43 percent of Zoomlion’s assets as of June 30 were payments the company expects to receive from customers and other counterparties, up from 40 percent at the end of 2010, data compiled by Bloomberg show. Zoomlion had about 14.1 billion yuan of “trade and other” receivables and 18.4 billion yuan of receivables related to its finance leases, compared with 75.2 billion yuan of total assets, the semi-annual report shows.
Sany Heavy’s receivables accounted for about 29 percent of assets at the end of June, while Caterpillar’s were about 39 percent as of Sept. 30, according to data compiled by Bloomberg.
‘Looks Like a Bank’
In addition to the receivables reported in its balance sheet, Zoomlion has provided about 10.4 billion yuan of guarantees for customers’ bank loans and third-party leasing agreements, according to the notes in its semi-annual report.
“It kind of looks like a bank,” said Anthony H. Catanach Jr., an associate professor at the Villanova University School of Business and the Cary M. Maguire Fellow at the American College Center for Ethics in Financial Services. “Almost half of their assets are from someone who owes them money. They’re functioning as kind of a lender to their buyers.”
Zoomlion’s operating cash flow, a measure of the cash generated by the business, was about 92 percent less than net income in the first half in part because its customers didn’t pay upfront, according to data compiled by Bloomberg.
“It causes a lot of pressure on the cash flows because you’ve sold the machines, but you haven’t gotten the money yet, so the balance sheet is looking stretched,” said Jefferies Group’s Bu. “That’s why these companies are coming to Hong Kong and trying to raise money.”
Zoomlion hasn’t reported a surge in bad debts. The company made payments of 38 million yuan in the first six months of this year to banks in relation to defaults on loans it had guaranteed for customers, down from 61 million yuan in the year-earlier period, according to the semi-annual report. Zoomlion has been able to sell repossessed machinery for amounts that aren’t “significantly different” from the guarantee payments, the company said.
Losses related to bad debts will increase as customers fall behind on payments, according to Villanova’s Catanach.
“There’s clearly going to be some reserves that are going to have to be set aside, which are going to impact the income statement,” Catanach said.
Zoomlion’s trade and other receivables due in one to three months rose 259 percent in the first half, compared with a 65 percent increase in receivables due within a month, according to the semi-annual report.
The company is considering acquisitions of machinery-makers in the U.S., Europe and Japan in part because the Chinese market is “too crowded,” Zhan, Zoomlion’s CEO, said in the interview. Sany Heavy said on Dec. 6 it plans to build factories in more than 10 foreign countries as domestic demand growth slows.
China has about 235 publicly listed machinery companies, compared with 174 in the U.S., 257 in Japan and 17 in Brazil, according to data compiled by Bloomberg.
“A lot of these companies are still producing a lot of equipment, so there could be a situation of supply outstripping demand in the short term,” said Aberdeen’s Yeo. “We’d prefer to be conservative and stay on the sidelines.”