Honghua dives on failure in quality audit
Honghua Group, the world's second-largest maker of land oil drilling rigs, plunged as much as 10.7 per cent yesterday after a surprise disclosure of a three-month-old failure to meet production quality management standards in North America.
The company said industry standards setter and auditor American Petroleum Institute (API) cancelled a number of Honghua's quality licences on April 13 after an audit based on revised requirements.
Honghua made the disclosure because it could not rule out being 'materially affected' prior to eventually receiving the licences, even though the issue had not had an impact on the company so far.
According to Honghua's listing prospectus in March last year, its API certification was due for renewal in July 2008. A Honghua spokesman said it was renewed, but due to a revision of requirements, Honghua's production process was re-audited this year.
When asked why the company only disclosed that the licences had been revoked a few months after it happened, the spokesman said management had been confident the issue would be rectified within a short time, but that it took longer than expected.
Honghua closed 7.49 per cent lower at HK$1.73.
The company said it had hired international consultancy ModuSpec International, under whose guidance Honghua has solved all the non-conformity issues, and it expected to meet API standards at the next audit at the end of August.
It has sought to mitigate the impact by outsourcing some production to API-certified suppliers.
The spokesman added that impact on the company is expected to be limited as North America only accounted for 7 per cent of last year's sales, and customers outside the region may still place orders since Honghua retained its international standard certification.
Larry Grace, a former oil sector analyst at Kim Eng Securities who had worked in the oil industry in the United States, said since API standards were highly regarded globally, it would likely have some impact on Honghua's sales outside the region.
Honghua sourced 10 per cent of its sales last year from the mainland, 8.8 per cent from the Middle East, 59 per cent from Europe and Central Asia and 6.9 per cent from South Asia.
Shenyin Wanguo analyst Zhang Yang estimated in a research note early this month, after discussing with management, that Honghua may only be able to deliver 80 oil rigs this year as customers reined in orders amid low oil prices. Honghua indicated a sales target in April of 94 rigs for the year.
It is forecast to post a 27.6 per cent decline in net profit this year to 370.79 million yuan (HK$420.66 million) from 511.97 million yuan last year, according to six analysts polled by Thomson Reuters.
Honghua won a US$120 million contract to sell an unspecified number of onshore rigs to Russian oilfield services provider Eriell. The contract amounted to about 18 per cent of Honghua's sales last year.
Earlier this month, it signed an agreement to build a US$300 million oil and gas drilling equipment production base in Jiangsu province. To be completed in 2012, it is expected to create annual revenue of up to US$3 billion and will allow the company to serve offshore oil drilling customers.
Limited impact
Of Honghua's total sales last year, North America accounted for only: 7%
