Recent negative developments on the S-chips

In the FY08 result season, a couple of S-chip companies were involved in unexpected events that resulted in trading halts and/or suspension. Common reasons include accounting irregularities and forced sale of owners’ pledged shares. Such events seriously dampened investors’ confidence in S-chip companies across the board.

Fibrechem requested a trading halt from 23 Feb 09, as the company and its auditor encountered certain difficulties in relation to the finalization of the audit of Fibrechem’s trade receivables and cash balances as at 31 Dec 08. Meantime, Mr James Zhang resigned from his position as Executive Chairman of the board. The company has appointed nTan Corporate Advisory as its independent investigator to carry out the investigation into the transactions in question. So far, no progress has been announced yet.

Beauty China has requested for 3 trading halts since 2 Mar 09. Its Chairman, Mr Wong Hon Wai, had pledged all his shares (137.5m shares, or 38.57% of the share capital) to obtain credit facilities. In order to fulfill his obligations to the financier, Mr Wong was forced to sell 28.8m of the mortgaged shares between 4 Mar and 6 Mar 09. Furthermore, on 6 Mar’09, the company was queried by SGX on its balance sheet regarding: (i) HK$42.4m impairment of trade receivables; (ii) 34.8% yoy increase of its trade receivables balance; and, (iii) 85.8% yoy increase of its other receivables balance. On 9 Mar’09, the counter requested for its 3rd trading halt within a week, pending release of announcement.

Sino-Environment’s play started on 2 Mar 09 when it requested for a trading halt after its full year results. In a similar scenario as Beauty China’s case, Chairman of Sino-Environment, Mr Sun Jiangrong, pledged all his shares (190.8m share or 56.29% of the share capital) to hedge funds. Forced sale of the pledged shares was triggered, as he failed to fulfill his financing obligations owing to the hedge funds. The possible change of control in the company further triggered bondholders’ rights to request for conversion and/or redemption of the outstanding SGD149m bonds, which the company was not able to afford. In view of this, nTan Corporate Advisory has been appointed as the independent financial advisor to carry out a review the implications and advise appropriate measures. The trading of this counter has been suspended since 6th Mar’09.

Oriental Century. Oriental Century, a 29.9% associate company of Raffles Education, has also called for a trading halt on 9 Mar. In an announcement released this morning, it was indicated that Oriental Century’s auditor, KPMG, was unable to ascertain the company’s bank balances. It was also indicated that Mr Wang Yuean, CEO of Oriental Century, had over the years inflated sales and cash balances and had diverted unspecified sums to an interested party. The trading halt had affected Raffles Education, which has fallen over 20% over 2 days. We believe this latest saga, is beyond fundamentals and will again strike at the confidence of investor on S-shares. Our recommendation and TP of Raffles Ed is currently under review.

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Fibrechem Technologies - Audit issues

Audit issues. Fibrechem posted during the lunch break that it has appointed Nicky Tan as an independent investigator and financial advisor. The official announcement says that there were certain difficulties encountered by auditors during the finalization of the audit of the group's trade receivables and cash balances. In short, accounting fraud - the worst-case scenario for the company. CEO James Zhang has offered to resign from his position as CEO and acting CEO Mr. Xu Xu Hui, takes his place. No information flow. We are still hitting a brick wall in getting any access to management or board member. Phone calls are unanswered - all we know is that the management team is currently in China.

Balance sheet shows no warning signs. We attach the last reported balance sheet of the firm. Revenue per quarter is about HK$480m while full-year revenue run-rate is HK$1.9bn to HK$2.0bn. Trade receivables stand at HK$280m. Although revenue growth was growing, trade receivables had not grown by much. Assuming all the current trade receivables are fictitious, net cash of HK$544m (S$0.12 per share) will be halved. Bigger problem would be if trade receivables have been made up all along and clients had been fictitious. This could transpire into a situation where even the cash on the balance sheet is not real. It is pointless to speculate at this point. Shares remain suspended, book value is S$0.62 but accuracy is in serious doubt, fair value is impossible to ascertain.

Suspending coverage. Our last target price was S$0.72 and our last rating was Outperform. We are suspending coverage on this stock until further information is disclosed.

Chemical Fibre Sectors - A Gloomy 1Q09 With Chinese New Year Approaching

The domestic chemical fibre industry entered and was trapped in a downcycle in 2008, with demand shrinking dramatically in a depressed export market for textile and garment products. The nylon industry is comparatively better off than other segments.

The downturn will continue in 2009 as the Chinese New Year (CNY) approaches. Since CNY will come slightly earlier than usual this year and business is expected to be poor, many companies have decided to shut down ahead of the Spring Festival holiday. The shutdown of many production facilities and the market's preference for cash over inventory during holidays have dragged down demand even more.

The post-holiday outlook does not look good either because many small textile and garment producers may not resume production so soon. Some have hardly received any orders for February onwards. Therefore, the outlook for chemical fibre producers in 1Q09 remains gloomy.

China Sky has shut down half of its production lines. It has also adopted strict credit policies that are likely to help lower default risks but will also hamper its efforts to secure orders and retain customers. Li Heng seems to be the least affected player, enjoying a high utilisation rate and maintaining its output at a level comparable to that seen in good times.

Fibrechem and Sino Techfibre are also badly hit, plagued by low utilisation rates. The short-term outlook will be worse than that in 3Q-4Q08. We are OVERWEIGHT on the chemical fibre sector despite the gloomy outlook mainly because of its low valuations. We believe current share prices have already factored in bearish market sentiment and any future downside will be limited.