• Negligible direct revenue exposure
• Systemic impact is specific
• Buy on price dips

Negligible incident-specific impact on CWT

Recently Dagang bonded warehouse at Qingdao Port was being investigated for the fraudulent practice of pledging single batches of metals as collateral for multiple loans. CWT’s revenue exposure to Qingdao port comes from collateral management service under its Logistics segment, which we understand from management is negligible. Thus, we do not expect Logistics earnings to be adversely affected.

Systemic impact centres on inwarehouse stock financing

The indirect impact of the Qingdao port incident comes from: 1) banks reportedly scaling back on loans backed by commodities, 2) banks seeking higher margins, 3) requiring buyers to be found first, and 4) moving collateral to better regulated locations outside China. Collectively, they will lower liquidity and commodity trade flows in China. We examined a similar steel-for-loan fraud in 2012 and found that the impact on futures market and physical trade flows were shortlived, lasting only up to a few months. We think it would be similar this time round unless the probe widens significantly. Moreover, given that CWT’s Logistics revenue exposure to China is less than 3%, the segment will be little affected by the systemic impact.

In addition, we expect Commodity Marketing earnings to be fairly resilient. We think the heat will be mostly felt by those reliant on in-warehouse stock financing, the current focus of the investigations. For in-warehouse stocks used to secure loans, they are typically held by a single party until no longer needed as collateral; this is different from Commodity Marketing (CM), where there goods are exchanged for money between two parties. While removal of leverage through tighter credit might drive metal prices down, we noted earlier that CM’s earnings are dependent upon volume flow and not prices.

Irrational fear presents opportunity to accumulate

We think indiscriminate fear of companies involved in China’s commodity business will arise should further negative news appear. Unless unforeseen legal liabilities arise, we think the subsequent price dips present chances for accumulation. Maintain BUY with S$1.92 fair value estimate.

Source: OCBC Research - 23 Jun 2014